Municipalities have welcomed certain changes to the Green Energy Act (GEA) which allow them to engage directly in certain electricity generation activities that have been denied to them since 1998. However, the GEA contains a potential tax trap for the unwary, that at this time remains unresolved.

The Electricity Act, 1998 (EA) created a requirement for all municipalities (i.e. "municipal corporations" under the EA) to divest all of their businesses that generate, transmit, distribute or retail electricity into city areas. These requirements are contained in Section 142 through 144 of the EA. The GEA has considerately liberalized this regime, and will permit municipalities to engage directly in the generation of certain kinds of electricity.

The GEA creates an exception to that "divestment" rule for facilities that generate less than 10 megawatts of electricity from "renewable" energy sources. However, this does not include facilities that produce, process, handle or store waste used to generate electricity. If these requirements are met, a municipal corporation may generate the electricity itself, without having to divest those generating assets.

In addition to the requirement for municipalities to divest themselves of their directly held generation, transmission, distribution and retail businesses, the EA also introduced a regime known as "payments in the lieu of taxes" (PILs). The PILs regime provides for payments in lieu of taxes, for "municipal electricity utilities" ("MEU") that are exempt from tax under the Income Tax Act (Canada) (ITA ). PILs are paid to the Ontario Electricity Finance Corporation for the purposes of retiring the stranded debt of Ontario Hydro. This also serves to create a "level playing field" between municipally owned electricity utilities and privately owned electricity utilities which would be ordinary tax-paying entities.

However, the definition of an MEU in subsection 88(1) of the EA is quite broad, and therefore many entities are caught which might not normally be suspected to be an MEU. For example, any municipal corporation (and therefore any municipality – although "municipal corporation" is not defined within the EA, the context indicates that they are implicated) that generates, transmits, distributes or retails electricity is considered to be an MEU, and because municipalities are exempt under subsection 149(1) of the ITA from the payment of Part I taxes, municipal corporations that engage in these activities are therefore directly subject to PILs.

It is extremely important to note in this context that all of an MEU's activities are subject to PILs, not only those involving electricity generation, transmission, distribution or retailing. In other words, if an entity is an MEU it must pay PILs on all of its income, as calculated under Part I of the ITA as if it were not exempt.

The GEA has, unfortunately, not amended the PILs regime in the EA to the same extent that it has modified the electricity holding company requirements as described above. Therefore, municipalities relying on the GEA exemptions in order to generate their own electricity may find that they have been inadvertently brought into the PILs regime as an MEU, and required to pay PILs in respect of all of their activities. We consider that this is likely an unforeseen circumstance; however, we have as of yet been unable to determine whether or not this is the case. Conversations with the Ministry of Finance, and the Ministry of Energy are ongoing with respect to their views on the PILs liability of municipalities relying on the GEA provisions to generate electricity.