Law Times

LAW TIMES / APRIL 7, 2008 The job is ensuring we have the energy A ll predictions are that Ontario's energy needs will start to outpace available production by about 2014, the exact timing de- pending upon the economy, weather, and other unpredict- able factors. Yet there hasn't been a sin- gle question raised about this looming scenario in the legis- lature since it resumed March 17. The 2014 situation will Inside Queen's Park By Derek Nelson But where are the new reac- be made even worse by the Liber- als' mindless commitment to shut down by the same date the Nanti- coke and Sarnia coal-burning sta- tions. And more so by the dithering they've shown these past four years towards nuclear. Under the best of conditions, it takes more than eight years to con- struct a nuclear plant from scratch, including more than two years for the environmental assessment and almost six years for construction. And no one pretends that in modern Ontario, with its changes in governments, its anti-nuclear ac- tivism, and NIMBY fanatics, that we have the best of conditions. The Liberals like to boast that they have brought thousands of megawatts of power online since they took over the government in 2003, but that is mythology. Most of that production was authorized by Conservative gov- ernments, before 2003, in an at- tempt to repair the damage done to Ontario's energy portfolio by the six years in office of the anti- nuclear New Democratic Party government of Bob Rae. Using über-bureaucrat Mau- rice Strong as its instrument, the NDP gutted Hydro's workforce of more than 10,000 employees, an inordinate number of them in the nuclear division. In 1995 Ontario Hydro was reeling from an 18,000-hour maintenance backlog. The Harris solution was to shut down eight of Hydro's 20 reactors so the utility could concentrate on making sure the rest were operat- ing properly. Shut down were the four Pickering A reactors east of Toronto and the four Lake Huron shoreline Bruce A reactors. The four reactors at each of Pickering B, Bruce B, and east-of- Oshawa Darlington continued to operate. The decision then had to be made about whether those shut- down eight should be "refur- bished," which really meant serious upgrading. In 1999 the Conserva- tives gave the go-ahead to fixing two units at Bruce (B3 and B4) and two at Pickering (P1 and P4). The Tories also tossed in a wrinkle. The Bruce plants were privatized and bought by a British energy company, while Pickering remained government-owned as part of the new generating com- pany Ontario Power Generation. As the four reactors slowly came back online, the Liberals took cred- it for having the power available. In fairness, however, in 2005 the Liberals also did OK the re- furbishing of Bruce A's B1 and B2 and have so far resisted luddite at- tacks on the reasonably balanced contract they signed with a private company to fix those reactors. tors — the reactors to replace P2 and P3, which will never be re- built, or to meet the closing of the coal plants and the refurbishing of other existing reactors as they age, and to meet expected demand in- creases for energy in coming years? Nowhere in sight. It's not that we don't have a so- lution. It's called the CANDU 6, built by Canada's own AECL. The most recent of these marvel- lous machines, the Cernavoda 2 in Romania, came online in late 2007 within budget and on time. In fact, since 1996 every single CANDU 6 built — one in China, two in Ro- mania, and three in South Korea — have all come in on time, or sooner, and within budget. Yet the CANDU 6 isn't even on the list of four reactor types, three of them untested, being considered by the Ontario govern- ment for a Darlington B project of four reactors. Finding out why is an interesting game. The word on the nuclear street is that the CANDU 6 is seen as obsolete, and unable to pass the Canadian Nuclear Safety Com- mission's (CNSC) criteria that any new Canadian reactors meet "in- ternationally accepted safety stan- dards and good practices based on experience and advances in knowledge gained in Canada and worldwide." Officially, the CNSC — the people who brought us the medi- cal isotope crisis — says only that it has never "completed a review of the CANDU 6 design so is unable to offer an opinion regarding the extent to which it meets modern standards." The nuclear industry itself, as engineering types always do, wants the most modern and up- to-date equipment, which in its eyes are the new so-called "third- generation" reactor designs. In CANDU's case, this is AECL's untested 1,000 MW Advanced CANDU Reactor or ACR. And untested, as AECL's Maple isotope reactors show, usu- ally means delay. Governments shouldn't be in the business of indulging either safety fanatics or engineering pur- ists. Its job is to ensure Ontario has the additional and replacement energy the province will need in the middle of the next decade. The CANDU 6 fits the need, and it is difficult to comprehend why the provincial government (and Ottawa) can ignore some- thing that Canadians finished building for foreigners as recently as 2007 — something that we know works and can be built on budget and on time. LT Derek Nelson is a freelance writer who spent 19 years at Queen's Park. His e-mail is jugurtha@rogers.com COMMENT PAGE 7 Taxation of income from intellectual property T here are only two substan- tive issues in the taxation of income from intel- lectual property. The first is to identify the nature of the income. The second is to locate its source for tax purposes, according to domestic and international law. They are difficult in bricks-and- mortar commerce. But in elec- tronic commerce they are that much more uncertain. The principle of tax neutrality requires consistent tax treatment for electronic and conventional modes of business. Thus, we should treat revenue from sales of hardcopy books in the same way as sales of digitized books. The difficulty is the two forms do not always offer identical products. The 1997 International Fiscal Association's general report says: "In many ways the treatment of software may be the best preview of the manner in which countries will be pre- pared to address the taxation of e-commerce in the coming years." There are significant differences in the taxation of software technol- ogy among member countries of the Organization for Economic Co-operation and Development. With masterful understatement, the report says, "The OECD com- mentaries have not been embraced universally . . ." Under international treaty rules, each category of income has its own source. We developed these rules in the 1920s as part of the process of determining the allocation of taxable jurisdiction between countries for different types of income. Income from sales of product generally derives from the seller's country of resi- dence, income from services from the country where we perform the services, and royalty income from licenses from where we use the intellectual property. Though some sources are more trouble- some than others, the rules work well in conventional commerce. Sourcing of income in e-com- merce is more difficult. Take the case of sales of digitized infor- mation such as a tax service. In conventional commerce, a pur- chaser buys the printed volumes of the tax services and the seller recognizes the revenue as income from the sale of tangible products, namely, books. This, even though most of the value of the services rests in their intellectual property and copyright, and not with their physical attributes. Indeed, the cost of printing and binding the tangible product is the least con- sequential component of its over- all cost. It is now possible to get the same product in CD-ROM for- mat or on the internet. These ser- vices entitle the purchaser to use the product without any owner- ship rights in it. The CD-ROM may have an unlimited or limited life. If the former, the transaction resembles a sale of print copy; if the latter, a license to use intellec- tual property for a term. In other cases, information is preinstalled on a computer, and www.lawtimesnews.com the purchaser is entitled to use the software. He may also have the incremental right to have the in- formation updated regularly. With internet services, the customer can sometimes opt for information to be "pushed" to him. Thus, the purchaser of the computer or service pays an ad- ditional built-in cost for future services. In these cases, the in- come derives from future services or from some combination of royalty and services income. For tax treaty purposes, we consider income to originate in the place where we perform the services. Financial By Vern Krishna The physical location of the ser- vice provider gives us a sufficiently independent and substantial nex- us to justify taxation. Does the sale of a product followed by electronic delivery generate business income or roy- alty income? The difference be- tween the two is substantial for OECD-based treaty countries. Business income is taxable on a net of expenses basis; royalty in- come is subject to withholding tax on a gross basis. At a glance, it appears the na- ture of income should not change merely because of the format of delivery of the product. But what is the "product?" A consumer, for example, may purchase software on a CD-ROM or by download- ing the software program directly from a web site. Both forms of the software ultimately serve the same purpose and will be subject to restrictive licensing agreements. The OECD Turku Report con- sidered the electronic purchase of a book as simply a substitute for a conventional hardcopy. But some forms of digitized information — like online subscription services to newspapers, tax reports, jour- nals — allow one to manipulate the data we have downloaded from the internet version. In these cases, it is arguable the consumer purchases not only the right to read the material but also to use and adapt it, by extracting ver- batim quotations to incorporate into textual material. Hence, a consumer may be purchasing ser- vices and not goods. In other cases, the distinction between online information is between royalty income and ser- vice income. A tax online service, allows one to access information about tax law directly through a subscription web site. In addition to the publisher's printed-copy information, however, the service also provides up-to-date case re- ports, government publications, forms, and press releases. The benefit of these services is they are available when government departments release them. The services, however, go even further; using push technology, they push the salient features of daily an- nouncements (accompanied by full-text releases) to the subscriber, via e-mail. Thus, a professional can access the most current infor- mation without effort to search for the information. The question: Is the subscrip- tion-service fee business, royalty, or services income? If the latter, the income should be taxable where the publisher provides Matters the service. Thus, in the context of an offshore user, it's arguable they provide the services on the publisher's Canadian web site. What if we reverse the situation and put the publisher's web site offshore in a tax haven? Based on the principles of tax neutrality, if we characterize the income as service income, the answer is that the income should be taxable in the jurisdiction where the publisher provides the service. The answer would be different if the income was sales income. Many commercial transac- tions involve elements of both the provision of tangible property and the performance of services. Where there is an overlap be- tween the provision of goods and services, we generally characterize the transaction according to its predominant characteristic. For example, the sale of a tangible product accompanied by a war- ranty produces sales income be- cause the after-sales service is only incidental to the sale of the prod- uct. In contrast, with professional services, the provision of the tan- gible property is usually incidental to the service itself. In such a case, the revenue is attributable to the service performed. Where we can distinguish the sale of the service from the sale of the product we can segregate the revenue from the two sources. Conventional commerce causes the same difficulties of char- acterizing the source and nature of revenues. The difference, how- ever, is in the speed of electronic transactions and the transfer of information in digitized form. As e-commerce accelerates, what was a small segment of income-char- acterization problems will become an increasing proportion of overall transactions. The opportunity to transmit and execute electronic transactions in low-tax jurisdic- tions without service disruption will be significant. In cyberspace, applying tradi- tional source notions to link an item of income with a geographi- cal location is difficult, if not impossible. Thus, e-commerce can render source-based taxation obsolete. In contrast, all taxpayers are residents somewhere. e. The U.S. recognizes that as traditional source principles lose their sig- nificance, residence-base taxation can take their place. The trend to residence-based taxation is likely to accelerate. Vern Krishna, CM, QC, FCGA, is counsel, Borden Ladner Ger- vais LLP and executive direc- tor of the CGA Tax Research Centre at the University of Ottawa. E-mail him at vkrishna @blgcanada.com LT

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