Determination No. R-2022-39

SUMMARY

[1] This determination sets out the Agency’s reasons for Determination R-2022-16 issued on February 11, 2022, on matters relating to the calculation of net rail investment and capital structure, which were the subject of consultations held in 2020 and 2021. The Agency uses these two components in calculating cost of capital rates for various railway-related costing determinations, including regulated interswitching rates and the Maximum Revenue Entitlement (MRE) for the movement of western grain.

[2] The Agency will address the following issues in this determination:

• Should a category of debt defined as “general purpose debt” issued by a railway company be included in the calculation of that company’s cost of capital rate?
• If this category of debt is included on the regulatory balance sheet, how should it be allocated between the railway company’s Canadian Rail operations (as defined in section 1203 of the Uniform Classification of Accounts and Related Railway [UCA]) and non-regulated activities?
• How should debt acquired, but not issued, by a railway company be treated?
• Should a negative working capital be allowed in the calculation of net rail investment?
• Should commercial paper be included in the calculation of working capital?
• Should the current portion of long-term debt be identified as a current liability or as long-term debt?

[3] For the reasons set out below, the Agency finds that the capital structure attributed to the Canadian Rail operations of a railway company must include the applicable portion of general purpose debt.

[4] The Agency finds that the most appropriate methodology for calculating the capital structure of a railway company’s Canadian Rail operations is the consolidated balance sheet approach.

[5] The Agency finds that the consolidated balance sheets of the Canadian National Railway Company (CN) and Canadian Pacific Railway Limited (CPRL) serve as an appropriate proxy for the capital structure attributed to their Canadian Rail operations for regulatory purposes. The Agency regulates CPRL’s Canadian Rail operations through the Canadian Pacific Railway Company (CP), a subsidiary of CPRL.

[6] The consolidated balance sheet approach takes all debt into account, including general purpose debt; deferred liabilities; and equity of the consolidated corporation.

[7] All balance sheet items necessary to determine CN’s and CP’s consolidated net rail investment and capital structure are defined in Appendix A of this determination.

[8] The Agency confirms that CN and CP must present their long-term debt at its face value in accordance with the principles set out in Decision 425-R-2011 and Determination R‑2017-198.

[9] The cost rate of equity will continue to be calculated following the methodology set out in Determination R-2019-229. Deferred liabilities will carry a cost rate of zero percent as per Determination R-2017-198.

[10] Notwithstanding paragraph 8, the Agency will consider special treatment of discounted debt if its methodology does not appropriately reflect the full cost to finance the debt. Having considered the circumstances raised by CN, the Agency finds that CN may specify its BC Rail Notes at market value with an imputed interest rate of 5.75 percent.

[11] On a case-by-case basis, the Agency will assess negative working capital amounts, and will make any required adjustments.

[12] The railway companies will have the option to treat short-term financial instruments and the current portion of long-term debt as long-term debt according to U.S. Generally Accepted Accounting Principles (U.S. GAAP) special rules.

[13] To ensure the alignment of regulatory reporting with this determination, the Agency will perform a detailed review of CN’s and CP’s regulatory balance sheet accounts and consolidating entries to the consolidated balance sheets beginning in the summer of 2022.

[14] The Agency will no longer issue annual call letters setting out the deadlines for CN and CP to submit their estimated cost of capital rate and the inputs used to derive this estimated rate. Instead, the Agency orders CN and CP to submit their estimated cost of capital rate and the inputs used to derive this estimated rate by March 1^st of each year, and to provide additional information to the Agency upon request.

[15] The Agency will not initiate a proceeding on its own motion under section 32 of the Canada Transportation Act, SC 1996, c 10 (CTA) with respect to CN’s and CP’s cost of capital determinations for the 2021-2022 crop year.

BACKGROUND

[16] The Agency establishes the cost of capital for CN and CP annually for various railway‑related costing determinations, including regulated interswitching rates and the MRE for the movement of western grain.

[17] For the Agency’s purposes, the cost of capital is defined as an estimate of the total return on net investment that a railway company requires in order to pay its debt costs relating to Canadian Rail operations and to provide its equity investors with a return on investment consistent with the risks they assumed for the period under consideration.

[18] The Agency includes a cost of capital allowance in its costing determinations to ensure that the rates it sets are fair and reasonable to all parties, including the railway companies and other stakeholders, in accordance with section 112 of the CTA.

REGULATORY FRAMEWORK

[19] Section 157 of the CTA confers broad discretion on the Agency in making cost of capital determinations.

[20] Subsection 157(1) gives the Agency the authority to make regulations prescribing items and factors to consider in determining costs under Part III of the CTA, including cost of capital. Subsection 157(2) sets out a non-exhaustive list of other matters the Agency may consider when it makes costing determinations, including at paragraph (b), developments in railway costing methods and techniques and current conditions of railway operations.

[21] When calculating the costs of a portion of a railway company’s operations, subsection 157(3) directs the Agency to include any costs of the whole railway or any other portion of it, that, in the opinion of the Agency, are reasonably attributable to the portion or operation, irrespective of when, in what manner or by whom the costs were incurred.

[22] CN and CP are required under subsection 157(5) to provide, in the form and manner specified by the Agency, the information that the Agency needs to make costing determinations. Pursuant to subsection 157(4), the Agency’s cost determinations are final and binding on all interested or affected parties.

[23] Within this context, the Agency made the Railway Costing Regulations, SOR/80-310. Under section 7, the Agency determines a cost of capital rate that it considers appropriate, which is applied to the variable portion of the net book value of rail assets.

[24] Section 156 of the CTA gives the Agency the discretion to define a uniform method of accounting for items relating to railway operations. The Agency has prescribed the UCA for CN’s and CP’s assets, liabilities, revenues, working expenditures, capitalization, traffic and operating statistics. The UCA provides accounting instructions, the framework of accounts and instructions for recording operating statistics. It also defines the categories for such data. Section 1104.01 of the UCA allows the Agency to issue interpretations of the UCA.

[25] The UCA provides a basis for comparing costs between the railway companies. CN and CP are required to keep their accounts in accordance with the UCA pursuant to subsection 156(5) of the CTA.

[26] The CTA does not mandate the use of the UCA for all regulatory determinations. It gives the Agency the discretion, when it makes cost of capital determinations, to consider broader information in establishing an appropriate cost of capital rate to allow debts to be paid and shareholders to be fairly compensated.

[27] In making costing determinations, and setting an appropriate cost of capital rate, the Agency must have regard for the provisions in Part III and the National Transportation Policy in section 5 of the CTA. The regulatory rate determinations supported by cost of capital determinations must be commercially fair and reasonable to all parties in accordance with section 112 of the CTA. It stands to reason that cost of capital rates must themselves be fair and reasonable. In addition to its focus on competition and efficiency, paragraph 5(b) of the CTA specifically calls for the use of regulation and strategic public intervention to achieve economic, safety, security, environmental or social outcomes that cannot be achieved satisfactorily by competition and market forces and do not unduly favour, or reduce the inherent advantages of, any particular mode of transportation.

OVERVIEW OF COST OF CAPITAL

[28] To set appropriate cost of capital rates, the Agency uses a Weighted Average Cost of Capital (WACC) approach. The WACC represents the proportion of each type of funding (i.e. debt, deferred liabilities and equity) in the capital structure attributed to the Canadian Rail operations of a railway company. This proportion is used to weight each cost rate and the sum becomes the cost of capital rate expressed in percentage terms. Ultimately, the WACC aims to capture a fair and representative weighting of each source of funds in the capital structure.

[29] This calculation addresses the costs of a railway company’s Canadian Rail operations. It is not meant to calculate the costs of a hypothetical railway company, nor the costs to replace the entire rail asset base. The cost of capital calculates the cost of financing existing rail assets and is not a calculation of raising capital to fund future rail assets.

Current methodology

[30] The principles currently used by the Agency in determining cost of capital rates were established in the following decisions:

• Cost of Capital Methodology Decision in the matter of issues pertaining to the Canadian Transport Commission’s Cost of Capital Methodology for Regulated Railways; and in the matter of proposed amendments to the Railway Costing Regulations related to Cost of Capital, issued by the Agency’s predecessor, the Railway Transport Committee (RTC) of the Canadian Transport Commission, dated July 31, 1985 (1985 Decision);
• Decision 125-R-1997—In the matter of issues pertaining to the Canadian Transportation Agency’s cost of capital methodology for regulated railways, dated March 6, 1997 (1997 Decision);
• Decision 425-R-2011—Review of the methodology used by the Canadian Transportation Agency to determine the cost of capital for federally‑regulated railway companies, dated December 9, 2011 (2011 Decision);
• Determination R-2017-198—Determination by the Canadian Transportation Agency of the methodology to be used by federally-regulated railway companies to determine the working capital amounts and capital structure for regulatory purposes, dated December 5, 2017 (2017 Determination);
• Letter Decision LET-R-41-2019—2019-2020 Crop Year Cost of Capital Rate for the Canadian National Railway Company (CN) for the Movement of Western Grain, dated April 30, 2019 (2019 CN General Purpose Debt Decision); and,
• Determination R-2019-229—Review of the methodology used by the Canadian Transportation Agency to determine the cost rate of common equity for federally-regulated railway companies, dated November 29, 2019 (2019 Determination).

Cost of capital determination process

[31] The cost of capital determination process for the Canadian Rail operations of each railway company consists of four distinct steps:

a. Determination of net rail investment;

b. Determination of the capital structure, which describes the proportions of various sources of financing used to acquire the capital assets of the Canadian Rail operations;

c. Determination of capital structure cost rates, which includes the cost rate of debt, deferred liabilities and equity; and

d. Calculation of the WACC rate.

a. Net rail investment

[32] The net rail investment is defined as the gross book value of all railway assets used in Canadian Rail operations less accumulated depreciation. This first component defines the portion of the railway company’s net assets that are providing railway transportation services and are under Agency jurisdiction. The net rail investment includes an amount for working capital. CN and CP make annual submissions regarding net rail investment, based on book values from their most recent financial statements, with certain Agency approved adjustments. These submissions are provided in accordance with the UCA and the methodology established in the 2017 Determination, and are verified by the Agency.

b. Capital structure

[33] The capital structure refers to the combination of the various sources of capital used to finance the net rail investment: debt, deferred liabilities and equity.

[34] Each year, CN and CP submit their actual capital structures, based on book values from their most recent financial statements, with certain Agency approved adjustments. These submissions are provided in accordance with the UCA and the methodology established in the 2017 Determination, and are verified by the Agency.

[35] Historically, Canadian railway debt and deferred liabilities for Canadian Rail operations were assigned to net rail investment. These items were thought to be identifiable to Canadian Rail operations because debt instruments were issued for specific purposes and deferred liabilities were generated from specific operations. The remainder of net rail investment was then assigned to equity.

c. Capital structure cost rates

[36] Each source of capital—debt, deferred liabilities, and equity—in the capital structure is assigned a cost rate.

[37] The cost rate of debt means the interest paid to financial institutions or bond holders for loans made to the railway companies, as recorded in the most recent financial statements of the railway companies and submitted to the Agency. These submissions are provided in accordance with the UCA and the methodology established in the 2011 Decision and 2017 Determination, and are verified by the Agency. Deferred liabilities are allocated a zero cost rate.

[38] The cost rate for equity is defined as the estimated return to shareholders that is required for railway companies to maintain access to equity for financing purposes. It is calculated using the Capital Asset Pricing Model as defined in the 2019 Determination.

[39] An income tax allowance, based on the railway company’s submitted statutory federal and provincial income tax rates, is added to the cost of equity to establish the before tax value of the shareholders’ return. No income tax allowance is applied to the interest paid on debt as it is income tax deductible.

d. WACC rate

[40] The proportion of each type of funding in the capital structure is used to weight each cost rate. The sum of these weighted rates becomes the cost of capital rate expressed in percentage terms. When this rate is applied to the net book value of the regulated assets, it results in the cost of capital in dollar terms.

Treatment of general purpose debt

[41] The Agency has addressed questions about the treatment of general purpose debt in various decisions and determinations.

[42] In the 1997 Decision, the Agency determined that CN must include its long-term debt on its regulatory balance sheet unless it can prove that the debt was raised for a specific non-rail purpose, or to finance U.S. rail operations. As a result, each debt instrument is assigned either 100 percent to Canadian Rail operations, partially to Canadian Rail operations, or excluded from it.

[43] In Decision LET-R-49-2009 (2009 CN Share Buyback Decision), the Agency found that, for CN, debt incurred for the purpose of share buybacks is rail-related within the meaning of the 1997 Decision.

[44] In August 2017 and on May 24, 2018, during a re-determination of the 2018-2019 volume-related composite price index in light of CTA amendments, CN asked the Agency to reconsider how it determines CN’s cost of capital rate after discovering that it had been reporting all of its general purpose debt as related to its Canadian Rail operations. The Agency informed CN that it would address the issue as part of a separate process.

[45] In the 2019 CN General Purpose Debt Decision, the Agency rejected two proposals by CN to allocate debt based on its consolidated company balance sheet, as it did not provide sufficient supporting evidence, or address differences in accounting rules between the UCA and U.S. GAAP. Pending completion of consultations, the Agency decided that, given the information provided, the most reasonable approach was to apply to the cost of capital determination for the 2019-2020 crop year an interim methodology based on revenue ton miles (RTM), which allocates debt to Canadian Rail operations and U.S. rail operations based on the proportion of traffic moved in each jurisdiction using reported RTM.

[46] In Determination LET-R-29-2020 (CP Cost of Capital Rate Determination for 2020-2021), the Agency addressed a previously unnoted difference in reporting by CP as compared with CN in determining CP’s cost of capital rate for the 2020-2021 crop year. The Agency determined that the use of general purpose debt for the purpose of share buybacks is rail-related and must be included in the determination of CP’s capital structure for the calculation of its cost of capital rate. As it had with CN, the Agency addressed the issue of reporting and allocating general purpose debt with CP by applying the same RTM methodology on an interim basis to CP’s general purpose debt for the calculation of its cost of capital, pending completion of consultations.

2020 CONSULTATION PROCESS

[47] On September 25, 2020, the Agency launched the Consultation on Cost of Capital Rates (2020 consultation) on five issues:

1: Should a negative working capital be allowed in the calculation of net rail investment?

2: Should commercial paper be included in the calculation of working capital?

3: Should the current portion of long-term debt be identified as a current liability or as long-term debt?

4: How should general purpose long-term debt of a railway company be apportioned between its Canadian Rail operations and non-regulated activities?

5: How should debt not issued by a railway company be treated?

[48] Stakeholders were invited to provide their input on these issues by November 25, 2020, and to submit responses to initial submissions by January 4, 2021. The Agency granted an extension until January 18, 2021, to file responses. Additionally, participants were granted an opportunity to respond to new materials raised by CP in its response. The comment period closed on January 29, 2021.

[49] The following stakeholders participated in the 2020 consultation:

• CN;
• CP; and
• Teck Resources Limited and its affiliates Teck Coal Limited and Teck Metals Limited (Teck).

[50] Teck also filed letters supporting its submission from the Western Grain Elevator Association, the Canadian Canola Growers Association and the Mining Association of Canada.

[51] Teck engaged Dr. Lawrence I. Gould, of the Asper Business School at the University of Manitoba, to provide his opinion on the issues raised in the 2020 consultation. Dr. Gould is a consultant on financial theory as applied to cost of capital calculations, and has provided expert witness statements in past Agency proceedings.

THE FEDERAL COURT OF APPEAL DECISION

[52] On April 9, 2021, the Federal Court of Appeal (FCA) quashed the CP Cost of Capital Rate Determination for 2020-2021 in part. The FCA found that the Agency had breached its duty of procedural fairness when it included general purpose debt in the calculation of CP’s cost of capital rate for the 2020-2021 crop year, and returned the matter to the Agency with the direction that it determine CP’s cost of capital rate for the 2020-2021 crop year using the same methodology used to calculate CP’s rate for the 2019-2020 crop year—that is, by excluding CP’s general purpose debt from the calculations (Decision 2021 FCA 69 [FCA Decision]).

[53] The FCA Decision left it open for the Agency to determine the proper characterization of general purpose debt following adequate consultation.

2021 CONSULTATION PROCESS

[54] On June 21, 2021, the Agency launched a consultation (2021 consultation) on the issue of whether general purpose debt should be included in the calculation of regulated cost of capital rates. This consultation included three questions:

1. Should general purpose debt be defined differently and if so, how?
2. Should general purpose debt issued by a railway company be included in the calculation of that company’s cost of capital rate?
3. Should general purpose debt be treated differently between railway companies?

[55] Stakeholders were invited to provide their input on this issue by July 22, 2021, and to respond to initial submissions by August 12, 2021.

[56] The Agency granted two extensions requests, one on June 22, 2021, and the other on July 29, 2021. As a result of these extensions, the consultation closed on September 9, 2021.

[57] The following stakeholders participated in the 2021 consultation:

• CN;
• CP; and
• Teck.

[58] CP engaged Dr. Michael W. Tretheway and The Brattle Group to provide their opinions on the issue raised in the 2021 consultation.

[59] Dr. Tretheway is the Executive Vice President and Chief Economist of the InterVISTAS Consulting Group and was involved in the regulatory process which created the Uniform Rail Costing System in the U.S. He has also provided expert witness statements in past Agency proceedings.

[60] The Brattle Group is a global economic consulting firm. The authors of The Brattle Group report are Dr. Matthew Aharonian, a financial economist, and Dr. Christine Polek, a Senior Associate at The Brattle Group. The authors have expertise relating to cost of capital issues for Canadian railway companies. Dr. Aharonian was a co-author of a 2010 Brattle Report that was prepared for the Agency during its 2010 Cost of Capital consultation.

[61] Teck engaged its finance expert, Dr. Gould, to provide his opinion on the issue raised in the 2021 consultation. Teck’s submission was supported by the Western Grain Elevator Association and the Canadian Canola Growers Association.

ISSUE 1: SHOULD A CATEGORY OF DEBT DEFINED AS “GENERAL PURPOSE DEBT” ISSUED BY A RAILWAY COMPANY BE INCLUDED IN THE CALCULATION OF THAT COMPANY’S COST OF CAPITAL RATE?

Consultation feedback

[62] Both CN and Dr. Gould agree with the Agency’s proposed definition of general purpose debt as “debt that is raised for broad corporate purposes—including share buybacks—as opposed to debt issued to finance specific identifiable assets.”

[63] CP does not agree with this definition, and believes that debt should only be defined as general purpose when it cannot be identified as debt raised or issued for Canadian Rail operations, U.S. rail operations or non-rail activities as prescribed by the UCA.

[64] CN suggests that identifying which debt was issued to finance a particular asset is challenging for two reasons. Firstly, the consolidated corporation raises debt and allocates it across Canada and the U.S., which introduces subjectivity in identifying the purpose of individual debt issuances. Secondly, all debt issuance is worded to indicate that it will be used for general corporate purposes.

[65] According to CP, general purpose debt is, by definition, debt that is not used to finance rail activities. Therefore, it should not be included in the regulatory accounts because it does not result from Canadian Rail operations (as defined by sections 1203.01 to 1203.03 of the UCA). CP claims that the UCA specifically instructs that such debt is not to be recorded in the regulatory accounts.

[66] CP disputes the Agency’s finding in the CP Cost of Capital Rate Determination for 2020‑2021 that section 1203.05 of the UCA is relevant to the inclusion of general purpose debt in the cost of capital calculation. That section states that, when a rail division is involved in non-rail activities, the resulting transactions must be recorded on the UCA balance sheet if they affect the current assets and current liabilities of Canadian Rail operations, or other assets and liabilities of these operations on a temporary basis. CP claims that the intent of this section is to avoid complicated adjustments to other accounts when dealing with temporary impacts of activities that change from rail‑related to non-rail-related activities. CP argues that this section does not apply to the activities of its parent company because it is not a “rail division”, that the issuance of long-term debt is not transitory, and that therefore this section does not apply to general purpose debt.

[67] Similarly, CP argues that share buyback debt should not be included in the definition of general purpose debt because share buybacks are the responsibility of CP’s treasury function and not the rail division, and therefore, CP claims that they are non-rail transactions. CP relies on section 1203.06 of the UCA, which states that the UCA accounts for items such as cash, accounts receivable and accounts payable will not be used when these items are the responsibility of a separate treasury function and not of the rail division.

[68] CN disagrees with CP’s characterization of share buybacks as treasury activities rather than general purpose debt. CN points out that CPRL’s 2020 Annual Report identifies CPRL as only operating in the rail transportation market, arguing that this demonstrates that all treasury activities must be rail-related.

[69] With respect to whether general purpose debt should be treated differently as between CN and CP, CP argues that the Agency must treat the two railway companies differently in order to achieve a fair and reasonable outcome for each. CP points out that the Agency has a history of treating CN and CP differently. CP asserts that the CP Cost of Capital Rate Determination for 2020-2021 did not appropriately consider CP’s unique corporate structure, nor the implications of including share buyback debt on the regulated balance sheet for CP’s regulatory accounts and regulatory capital structure, when the Agency applied to CP the approach set out in the 2009 CN Share Buyback Decision.

[70] CP observes that the Agency has departed from rigid mechanics in the past to provide fair and reasonable outcomes, as it did when it used information from CP to determine CN’s cost of equity at a time when CN did not have complete public market information due to its corporate structure. CP also argues that CN’s current requests relating to the accounting treatment for its BC Rail debt (Issue 3) and for its commercial paper (Issue 5) demonstrate that it also believes its situation is unique.

[71] CP submits that if general purpose debt is to be included on the regulatory balance sheet, then general purpose equity must also be included. CP points out that it has been excluding general purpose equity from the regulatory balance sheet.

[72] CP also requests that the Agency hold a bilateral and confidential consultation to resolve the issue of how to allocate general purpose debt to the regulatory balance sheet if the Agency determines general purpose debt must be included.

[73] Both CN and Dr. Gould submit that general purpose debt should be included in the cost of capital determination, and that CN and CP should be treated the same with respect to the inclusion of general purpose debt. Although CP believes that the railway companies should be treated differently due to their differing corporate structures, CN does not view these differences as a valid reason for differential treatment. CN argues that the cost of capital of a railway company is independent from its corporate structure, and that both railway companies raise funds in the same market and face similar risks. CN explains that if the Agency accepted CP’s proposed interpretation, such a ruling would imply CN could effectively earn additional revenues for rail service, simply by rearranging its corporate structure, which would have no impact on the economic costs associated with raising the funds.

[74] Both CN and CP agree that a railway company has no specific purpose in mind when it issues debt, and that a debenture cannot be linked to a specific asset or activity. CP states that railway companies do not usually identify a specific use for debt in their public disclosures, and that it would be inappropriate to limit their use of debt in this way. CP agrees with CN that it is very difficult, if not impossible, to prove that funds were raised for a specific project.

Analysis and determination

DEFINITION OF GENERAL PURPOSE DEBT

[75] CP proposes to define general purpose debt as debt that cannot be identified as being raised or issued for Canadian Rail operations, U.S. rail operations or non-rail activities as prescribed by the UCA.

[76] The Agency rejects CP’s definition because the Agency does not agree with CP’s view that sections 1203.01 to 1203.03 of the UCA exclude general purpose debt from Canadian Rail operations. While CP contends that such debt is not used to finance rail activities, the evolution of CP’s business operations helps to illustrate what these sections of the UCA were intended to address. CP had a diversified business prior to 1971. In that period, the treasury functions involved a range of non-railway corporate activities, and it was important that financial information for the operations and activities of CP Air and CP Hotels was not captured in the UCA accounts.

[77] However, as CN notes, CPRL’s 2020 Annual Report to shareholders on page 28 states that, “The Company operates in only one operating segment: rail transportation”.

[78] The Agency finds that the scope of the UCA set out in section 1203 allows railway companies to differentiate, for reporting purposes, between Canadian Rail operations, U.S. rail operations and non-rail activities. The definition of “Canadian Rail operations” describes the business activities regulated by the Agency, regardless of where these activities are carried out within the corporate structure governing the railway company. The Agency therefore does not accept that the financial activities of CP’s parent corporation‒that only operates in rail transportation and supports Canadian Rail operations‒can be considered to be stand-alone non-rail activities. The Agency finds that it is incorrect to interpret these sections of the UCA to exclude general purpose debt entirely in these circumstances.

[79] Similarly, the Agency disagrees with CP’s argument that section 1203.06 of the UCA excludes debt raised for the purposes of the share buyback program from the regulatory balance sheet simply because the treasury department of the consolidated corporation handles the share buyback program. The Agency does not accept that a CPRL share buyback program can be characterized as a non-rail activity. As well, the Agency is of the view that CP’s interpretation of section 1203.06 does not consider that section within its context in the UCA.

[80] Sections 1203.04 to 1203.06 of the UCA provide instructions to exclude non-rail activities from the UCA accounts, unless—as provided in section 1203.05 of the UCA—non-rail transactions affect the assets or liabilities of Canadian Rail operations on a short term or temporary basis. Thus, section 1203.05 does not address long-term or general purpose debt. While section 1203.06 of the UCA excludes items that are the responsibility of a separate treasury function from the UCA accounts, its focus is on short term transactions. The accounts listed in that section are all current assets and liabilities, with the exception of UCA account 23 (Long-Term Accounts Receivable), which consists of receivable balances due after one year. Notably, section 1203.06 does not refer to any long-term or non-current liabilities (UCA accounts 61-75) or equity (UCA accounts 81-87).

[81] The Agency therefore finds that, given the context of sections 1203.04 to 1203.06 of the UCA and the types of accounts referenced in section 1203.06, that section does not apply to all activities of the treasury department, and that in particular, it does not apply to activities relating to long-term debt and equity.

[82] UCA account 87 (Net Investment in Rail Assets) provides instructions to account for equity that was not raised by the rail division itself to carry out Canadian Rail operations. CP uses UCA account 87 to record intercompany cash transfers between itself and its consolidated corporation. By excluding general purpose debt raised by CPRL from its regulatory balance sheet for Canadian Rail operations, CP chooses to record proceeds from such debt as equity through an intercompany cash transfer under UCA account 87.

[83] In practical terms, this approach leads to an overstatement of equity on the regulatory balance sheet, as demonstrated by a review of CP’s balance sheet. This is presented in the confidential tables in Appendix C, which compares CP’s capital structure in 2007 and 2020, as reported in CPRL’s annual reports to shareholders, with the capital structure of CP’s Canadian Rail operations, as reported to the Agency.

[84] In 2007, CP’s corporate capital structure was predominately equity, followed by debt, and then deferred liabilities. In 2020, the relative proportions of debt and equity had changed position in its externally reported capital structure, yet CP continued to represent equity as outweighing debt in its reporting to the Agency, which appeared to underrepresent debt, and to overstate equity.

[85] CN also uses account 87 of the UCA for its reporting; however, the results of its approach are markedly different. There is close alignment between CN’s consolidated public reporting and its reporting to the Agency. This is because the CN treasury function is treated as part of rail activities, as it supports the rail business.

[86] In light of this, the Agency concludes that CP has adopted a technical and narrow reading of the UCA instructions for accounting purposes. This reading does not generate an accurate and reliable result that fulfills the purpose of cost of capital determinations, which is to reflect the actual cost of financing existing rail assets. The Agency finds that the UCA must be given a contextual and purposive reading that is consistent with that purpose.

[87] Both railway companies agreed during this consultation that the capital structure of Canadian Rail operations should be comparable to that of the consolidated corporation. However, by overstating the portion of the capital structure which is actually financed by equity, CP’s interpretation would effectively allow funds raised through the issuance of debt to earn a return based on the higher average cost of equity rate simply through the use of a treasury department located in a separate corporation.

[88] The Agency also rejects CP’s argument that share buybacks should be excluded because they are not rail-related. Again, the purpose of cost of capital determinations is to reflect the actual cost of financing existing rail assets. If existing rail assets were purchased with equity and that equity were subsequently replaced or “bought back” with debt, then the cost of financing these rail assets would be affected, and this change must be incorporated in the calculation in order to reflect the actual cost of financing existing rail assets.

[89] The Agency accepts CN’s and CP’s argument that money is fungible and that it is impossible to track how a given dollar has been used once it has been raised by the company. As noted by CP, each dollar enters a common pool of available funding, which is drawn upon to meet operating expenses, investment financing and other business needs.

[90] However, in the same vein, it cannot be said that only non-rail-related equity is affected by CP’s share buyback program. CPRL has purchased back a portion of its equity using debt. This higher cost equity, which was used to finance CPRL’s assets and business activities, including those related to rail activities, has been replaced with lower-cost debt, reducing the actual cost of financing the assets and activities. This situation is similar to a consumer replacing a higher interest credit card debt with a lower interest credit card, or a homeowner paying off part of their higher interest mortgage with a lower interest home-equity line of credit. In both cases, the asset remains; however, the cost of financing has been altered and this change must be captured.

[91] Given the evidence provided during these consultations, the Agency cannot accept CP’s interpretation of the UCA and resulting reporting approach when the results do not represent the actual methods by which CPRL raises funds. CP’s treatment of CPRL’s debt-raising activities leads to a large variance between CP’s publicly reported results and its reporting to the Agency, based on a factor that cannot be reasonably assumed to have a real economic impact on the cost of financing a business.

[92] As a result, the Agency defines general purpose debt as “debt that is raised for broad corporate purposes—including share buybacks—as opposed to debt issued to finance specific identifiable assets”.

INCLUSION OF GENERAL PURPOSE DEBT

[93] As set out in paragraph 7(b) of the Railway Costing Regulations, the Agency’s role is to determine an allowance for cost of capital based on an appropriate rate of return for debtholders and shareholders. The cost of capital rates that are established not only need to be fair and reasonable for each individual railway company, but also need to be comparatively fair and reasonable as between the two railway companies.

[94] In the past, the Agency’s financial analysis was tailored to both CN and CP due to the diverse business interests of their consolidated corporations. However, there is very little substantive difference between the modern versions of CN and CP. Both companies acknowledge that their consolidated corporations are rail transportation companies.

[95] The Agency has historically relied on the UCA balance sheet to make the annual cost of capital determinations, as it found that the balance sheet accurately linked the financing of Canadian rail assets to the sources of funds used by the railway companies. However, the evidence filed during these consultations shows that this is no longer the case for CP, as the UCA balance sheet currently reported by CP does not capture this linkage.

[96] In particular, CP’s interpretation of the UCA as it applies to intercompany transfers of the proceeds of CPRL’s general corporate issuances has led to a significant divergence between how CP and CN report the various sources of financing for their disaggregated rail operations.

[97] The only identified difference between CN and CP is the placement of their treasury departments within their broader corporate structures. CP seems to suggest that placing the treasury department outside of the railway company limits the Agency’s ability to consider the impacts of treasury actions due to the specific wording of the UCA. However, any ambiguities in the UCA must be read in light of the Agency’s broad costing authority. The Agency must determine an appropriate cost of capital rate for Canadian Rail operations in accordance with section 7 of the Railway Costing Regulations. Subsection 157(3) of the CTA requires the Agency to determine the costs that are reasonably attributable to these operations, irrespective of who incurs those costs or in what manner they are incurred. The Agency finds that the UCA must be read in a manner that is consistent with this statutory authority and the underlying purpose of costing determinations.

[98] The fact that CP uses the treasury department of its consolidated corporation, CPRL, to raise funds does not mean that CP can alter its reported capital structure, nor should CN be encouraged to undergo corporate restructuring to achieve a similar result. This would directly undermine the purpose of cost of capital determinations made by the Agency, and cannot reasonably be understood to be an intended outcome of the CTA, the Railway Costing Regulations and the UCA.

[99] The Agency sees no reason why the cost of funding Canadian Rail operations should be impacted by the location of the treasury function within the railway company’s corporate structure, as its location has no impact on the rate of return required by debtholders and shareholders. The determination of the reasonable cost of financing rail assets must instead depend upon market variables.

[100] Both CN and CP indicate that funds for business activities are raised by their consolidated corporations, and that these corporate funds are used to finance operational requirements. There are no longer clear linkages between individual assets and the sources of funds used to finance them: when a railway company purchases a new locomotive, it is seldom directly linked to a specific financial instrument. As a result, the Agency finds that the capital structure attributed to the Canadian Rail operations of a railway company must include the applicable portion of debt financing from the common corporate pool of funds so that the cost of capital determination accurately reflects the sources of financing for these operations.

[101] The Agency will therefore include general purpose debt in the determination of both CN’s and CP’s cost of capital.

ISSUE 2: IF A GENERAL PURPOSE DEBT CATEGORY IS INCLUDED ON THE REGULATORY BALANCE SHEET, HOW SHOULD IT BE ALLOCATED BETWEEN THE RAILWAY COMPANY’S CANADIAN RAIL OPERATIONS (AS DEFINED IN SECTION 1203 OF THE UNIFORM CLASSIFICATION OF ACCOUNTS AND RELATED RAILWAY [UCA]) AND NON‑REGULATED ACTIVITIES?

[102] The Agency’s authority to make cost determinations includes apportioning an appropriate amount of general purpose debt to Canadian Rail operations.

[103] As discussed above, general purpose debt is not raised for any one specific purpose and enters a pool of funds from which all divisions, including the Canadian rail division, can obtain funds. In light of this, the Agency must find a way to apportion general purpose debt between Canadian Rail operations and non-regulated activities. Because the modern versions of CN and CP are rail transportation companies, the Agency chose, pending completion of consultations, to use the RTM methodology, which apportions general purpose debt based on the proportion of revenue tonne miles attributable to Canadian Rail operations versus U.S. rail operations.

Consultation feedback

[104] Teck has concerns with the transparency of railway company information. It submits that it does not have, nor can it obtain, the relevant information about the Canadian Rail operations of CN and CP that it needs to properly respond to the issues in this consultation.

[105] CN does not agree that debt should be allocated between Canadian and U.S. operations. CN submits that debt instruments are not issued for one single purpose or jurisdiction. Consequently, any allocation will suffer from discrepancies between different interpretations of the purpose of debt instruments.

[106] CP submits that general purpose long-term debt should not be allocated to Canadian Rail operations, as it claims that this type of debt is issued by CPRL for the primary purpose of share buyback programs to maintain a target capital structure at the corporate level, and not to finance its rail activities. It also reiterates its arguments that the UCA excludes general purpose long-term debt from Canadian Rail operations.

[107] CP argues that if the Agency decides to allocate general purpose long-term debt to Canadian Rail operations, then it must also allocate the general corporate activities that reside on the books of its parent company, including debt, equity, assets and working capital. CP submits that failing to start with the entire balance sheet will result in distortions and systematic biases in the results, which it claims occurred in the CP Cost of Capital Rate Determination for 2020-2021.

[108] CP claims that the Agency erred when it added general purpose long-term debt to CP’s regulated balance sheet and reduced equity to maintain balance.

[109] CP claims that much of the general purpose debt that was allocated to CP’s balance sheet was raised to finance share buybacks. CP submits that its parent company originally issued the public shares, and thus, the share-capital resides on CPRL’s balance sheet and not on that of the Canadian Rail operations. It argues that the CP Cost of Capital Rate Determination for 2020-2021 effectively had the Canadian Rail operations issuing debt to buy back the shares of CPRL, without allocating any of CPRL’s equity to those Canadian Rail operations.

[110] CP claims that the Agency’s decision resulted in CP incurring the cost of the share buyback program twice: once when CPRL retired the repurchased shares, and again when the Agency reduced the equity of the Canadian Rail operations. CP argues further that, because the share capital resided on CPRL’s balance sheet, the Agency arbitrarily reduced the retained earnings and paid-in-capital of the Canadian Rail operations.

[111] CP claims that it applied a balanced approach to its UCA ledger and that further adjustments were not required. CP submits that it eliminates several billion dollars’ worth of non-rail equity each year when preparing its regulatory balance sheet as, in its opinion, these equity balances represent non-rail transactions pursuant to UCA accounting principles. These equity balances include items such as transfers of cash to the parent company to finance share buybacks and payment of dividends on behalf of other CP subsidiaries. CP submits that these transactions provide a general corporate benefit by financing dividend payments to shareholders including employees, and financing share buybacks to maximize earnings and share value.

[112] CP also submits that the Agency must ensure that any adjustments will lead to a capital structure that is reasonable for the Canadian Rail operations as well as for the consolidated corporation and its other divisions. CP claims that the capital structure of the Canadian Rail operations that resulted after the Agency allocated a significant amount of general purpose long-term debt did not resemble the capital structure of the rest of the company.

[113] Both CN and CP disagree with the RTM methodology of apportionment of debt applied by the Agency. CP argues that RTM affect equity, not debt, because they are the primary driver of freight revenues, and that they represent the company’s primary means of generating income and retained earnings.

[114] CN submits that the RTM methodology is flawed for the following reasons:

• Funds to generate RTM are not one-to-one across jurisdictions because many Canadian properties were funded by CN over the last 100 years at levels much lower than recent U.S. acquisitions. This can be corrected if the Agency allowed for the removal of long-term debt that was used to fund U.S. acquisitions, including long-term debt that was rolled over at maturity into new debt instruments.
• Some infrastructure investments such as safety, network fluidity and/or service improvements may not increase RTM.
• Investments required in the Prairies are not the same as those required in Wisconsin to generate the same RTM. Furthermore, maintenance and renewal costs are less in the Prairies but generate a large portion of CN’s RTM.
• Not all RTM generate the same revenue, and they may not attract the same level of investment.

[115] CN uses information from its annual reports to compare the proportional book value of its properties in Canada and in the U.S. with the proportion of its total RTM generated in each country to show that RTM and investment do not represent a one-to-one relationship. From 2017 to 2019, the average Canadian share of the book value of CN’s properties was 53.3 percent, while the average Canadian share of RTM over the same period was 73.6 percent of its total RTM.

[116] CN states that the investment costs in properties per RTM are much higher in the U.S. than in Canada. It required an average of 2.4 times more property investment in the U.S. to generate the same RTM from 2017 to 2019.

[117] CN also indicates that the revenue per RTM was lower in Canada than in the U.S. by a factor of roughly 0.75 between 2017 to 2019.

[118] Both railway companies propose alternative methodologies to allocate general purpose debt, which they prefer over the RTM methodology:

• CN proposes to allocate based on the gross book value of its investment properties’ cost (GBV methodology), where any investments that can be assigned to specific operations (either inside or outside Canada) are removed prior to allocation.
• CP proposes to allocate based on the ratio of the total net book value of Canadian railway properties to the net book value of the consolidated corporation’s properties (NBV methodology).
• CP proposes to show its share buyback activity at the parent company level as CPRL issues CP’s public equity and to add an asset on CP’s balance sheet so that rail-related equity is not eliminated. CP claims that it is necessary to add debt to the regulatory balance sheet, and then show the railway company advancing the proceeds to the parent company so that it can perform the share buyback.
• CP proposes to fully allocate all general purpose activities, including general purpose equity, between Canadian and non-regulated operations.

[119] Dr. Gould comments that CP has not provided information on the specific general purpose assets to be allocated under its proposal and the rationale for their inclusion. He submits that stakeholders should be permitted to comment on any specific general purpose assets that CP proposes to allocate.

[120] Dr. Gould examines two ways to calculate a company’s capital structure: the net method and the gross method. Dr. Gould demonstrates that both the gross and net methods yield the same results in calculating the earning requirements for different divisions within a corporation. The gross method would result in different costs of capital for each division and for the consolidated corporation, because the divisions would differ with respect to operating and tax-source capital. If the net method is used, the cost of capital will be the same for each division and for the consolidated corporation. In that scenario, Dr. Gould concludes that the cost of capital of the consolidated corporation may be applied to each division.

[121] Dr. Gould argues that, in situations where a particular division of a corporation is regulated by the Agency, it is both correct and desirable to deduct the specific sources of operating or tax capital from the rate base, and then use the WACC derived from investor-supplied capital and nonspecific sources of capital, as in the case of the net method. CN agrees with the use of the net method.

[122] CN acknowledges that the Agency has previously rejected the use of an allocation methodology unless it reconciles with the UCA; however, CN states that investors or lenders do not refer to the UCA to assess their expectations, nor does the CTA dictate the exclusive use of the UCA. CP agrees with CN that the CTA does not dictate the exclusive use of the UCA.

[123] Both CN and CP agree that the best approach is to use the capital structure as presented on their consolidated balance sheets. CN submits that there is currently a disconnect in the Agency’s calculation because it determines the cost of equity based on the consolidated corporation, but does not use the cost of capital of the consolidated corporation.

[124] CN submits that only its consolidated corporation issues debt and equity on the market, and not its Canadian or its U.S. operations. CN claims that capital and debt is raised in a market that relies on the consolidated financial statements of corporations for financial decisions. Because the market expects a return based on CN’s consolidated financial statements, the Agency should use the capital structure as presented in the consolidated balance sheets of CN’s annual reports for its cost of capital determinations. Similarly, CP submits that the Agency should use the capital structure of CPRL for the estimation of CP’s cost of capital.

[125] CN argues that that the situation would be different if it had one division with risk comparable to a low-risk regulated utility and another division with high-risk speculative operations. However, CN submits that 95% of its total revenues are from freight revenues and the other 5% of its total revenues are from non-rail logistic services that support its rail business. Therefore, CN submits that 100% of its revenues are from rail freight and supporting services.

[126] Dr. Gould submits that it is incorrect to allocate general purpose long-term debt to the regulated balance sheet based on the debt-to-equity ratio of the consolidated balance sheet. He argues that the Canadian Rail operations should be treated as an independent company, and have a separate balance sheet reflecting the capital structure of that entity.

[127] Dr. Gould is also of the view that it is appropriate to use the RTM methodology to allocate general purpose long-term debt, based on the premise that there is a logical link between revenues earned and the investment in assets. He also prefers the RTM methodology because it does not require reconciliation between different accounting systems.

Analysis and determination

ALLOCATION USING THE RTM METHODOLOGY

[128] Both CN and CP take issue with the RTM methodology. The Agency used the RTM methodology in 2019 on an interim basis. However, based on the evidence of how the railway companies currently raise financing and distribute it within their corporate structures, the Agency agrees that the RTM methodology is not a good representation of where funds are invested.

ALLOCATION USING THE GBV OR NBV METHODOLOGY

[129] Both CN and CP prefer the GBV and NBV methodologies for allocating general purpose debt, arguing that these methodologies produce results that better resemble the capital structure of their respective consolidated companies. However, the Agency is concerned that neither methodology reflects the railway companies’ true financing requirements. The proper dollar amounts may not be allocated to a railway company’s balance sheet due to differences in UCA and U.S. GAAP reporting, which would lead to an under-or over-allocation to the various funds used to finance the net rail investment, affecting the relative weighting of these funds.

[130] The GBV methodology was previously considered by the Agency in Decision LET‑R‑33‑2019 (2019 CN Show Cause Decision) and in the 2019 CN General Purpose Debt Decision, and no evidence has been produced, or arguments made, in these consultations that changes the Agency’s analysis of the shortcomings of this methodology.

[131] The Agency rejects CP’s claim that the NBV methodology is similar to the proxy used in the calculation of the cost of equity rate. Because both consolidated corporations issue equity in both Canada and the U.S., the Agency decided in the 2019 Determination to use a combination of the U.S. and Canadian cost of equity estimates as a proxy for the rate of return required under a North American Capital Asset Pricing Model. This blended estimate is applied as a proxy to the remaining balance of net rail investment. The entire net rail investment, including the balance attributed to equity, follows the UCA. As a result, there is no impact from the application of different accounting standards, or allocation between jurisdictions. Instead, the Agency uses the blended estimate to represent the North American market as accurately as possible.

[132] By contrast, the GBV and NBV methodologies attempt to allocate general purpose debt between Canada and the U.S. based on the ratio of asset values in each country using U.S. GAAP accounting instead of UCA accounting. In this case, there could be a meaningful variance in the allocation of general purpose debt using U.S. GAAP as compared to UCA standards, because the underlying rules may change these ratios. This is consistent with the Agency’s findings in the 2019 CN Show Cause Decision and in the 2019 CN General Purpose Debt Decision.

[133] For example, under the UCA, the railway companies are allowed to directly claim labour expenses associated with programmed track replacement, which would typically be included as part of the capitalization of such items under U.S. GAAP. It is unclear how these differences would impact the relative balances in Canada and in the U.S., where labour rates and cost of materials may be different. Because of differences between pension plans in Canada and in the U.S., the Agency has similar concerns in relation to the pension asset included in net rail investment, if pension accounting is done in accordance with U.S. GAAP.

[134] The potential mismatch arising from the differential treatment between the UCA and U.S. GAAP reporting could result in the NBV or GBV methodologies allocating either too much debt, which would reduce the share of equity in net rail investment, or too little debt, in which case, equity would need to cover the imbalance. In both cases, the resulting capital structure may not reflect the sources of funds for the consolidated corporation or for Canadian Rail operations. Based on these concerns, the Agency would require detailed reconciliations to ensure such variations do not invalidate the proxies.

[135] To support the NBV methodology, CP claims that it can produce a statement of all its corporate properties following UCA accounting standards in approximately six months; however, CN submits it would need to revisit every engineering project and mechanical repair in the last 25 years to produce UCA-compliant accounts for its U.S. operations.

[136] The Agency is also not convinced that either methodology is a reasonable approach for the calculation of the cost of capital, given the resources that would be required for each railway company to produce a UCA balance sheet for its entire corporation and the Agency resources that would be required to verify such a balance sheet.

ALLOCATION USING PARENT COMPANY SHARE BUYBACKS

[137] CP’s first alternative proposal is to add the general purpose debt to the regulatory balance sheet, and then show CP advancing the proceeds to the consolidated corporation so that it can perform the share buyback. To show the advancement of proceeds, CP suggests a receivable asset will be generated on the regulated balance sheet. However, it is unclear what proceeds CP is advancing to its consolidated corporation when it is the consolidated corporation that has issued general purpose debt for the purpose of share buybacks and thus has retained the proceeds from that issuance to buyback shares.

FULL ALLOCATION OF ALL GENERAL PURPOSE ACTIVITIES

[138] CP’s second alternative proposal would allocate general purpose equity in addition to general purpose debt to the regulatory balance sheet. However, this allocation methodology would require the use of either the GBV or NBV methodology, which as discussed above, may not reflect the sources of funds either at the consolidated corporation or for Canadian Rail operations exclusively.

ALLOCATION USING THE CONSOLIDATED BALANCE SHEET APPROACH

[139] CN previously proposed a consolidated balance sheet approach, which the Agency rejected in the CN 2019 Show Cause Decision and in the 2019 CN General Purpose Debt Decision. In its final comments on the 2020 consultation, CN proposes an alternative methodology that uses the total assets of the divisions to distribute the consolidated corporation’s balance sheet to its divisions. CN demonstrated that this methodology would result in a cost of capital for all divisions that is equal to that of the consolidated corporation.

[140] Dr. Gould submits that the consolidated balance sheet approach is not correct, as it is the cost of capital for Canadian Rail operations that the Agency is attempting to estimate, not that of the consolidated corporation. However, the Agency must consider the new submissions of CN and CP, which show that the majority of the debt issued by the consolidated corporation is not for a single purpose, but rather “for general corporate purposes”, and that every dollar raised enters a common pool from which the railway companies and the other subsidiaries and divisions can draw money. Because of this, there is in fact no individual cost of capital for each subsidiary or division and the cost of capital for Canadian Rail operations is that of the common pool of the consolidated corporation.

[141] Using the capital structure of the consolidated corporation does not require reconciliation to the UCA as it does not affect the UCA dollar amounts in the net rail investment. It also aligns with the Agency’s current methodology for calculating the cost of equity, which uses the returns of the consolidated corporation as a proxy for those of the Canadian Rail operations.

[142] Another benefit of this approach is that the calculation requires fewer resources for all involved, including the Agency, as it uses the capital structure of the consolidated corporation, which is already publicly available and audited. Furthermore, it will be more transparent to shippers, as the capital structure that the Agency’s cost of capital determination is based upon will no longer be confidential.

[143] While this approach represents a departure from the previous UCA-based approach, the Agency finds that the use of the consolidated balance sheet is warranted in light of the proposals and evidence presented during this consultation process. Using the consolidated balance sheet in the cost of capital exercise takes into account developments in railway costing methods and techniques, and current conditions of railway operations, as contemplated in paragraph 157(2)(b) of the CTA. This approach also aligns with the goals of competition and strategic regulatory intervention as set out in the National Transportation Policy, and helps to achieve an appropriate cost of capital rate as contemplated by section 7 of the Railway Costing Regulations.

[144] For these reasons, the Agency finds that the consolidated balance sheets of CN and CPRL serve as an appropriate proxy for the capital structure attributed to their Canadian Rail operations for regulatory purposes.

[145] The consolidated balance sheet approach takes all debt into account, including: general purpose debt; deferred liabilities; and equity of the consolidated corporation. All balance sheet items necessary to determine CN’s and CP’s consolidated net rail investment and capital structure are defined in Appendix A.

[146] The Agency confirms that the consolidated balance sheet approach requires the railway companies to present their debt instruments at face value to conform with the 2017 Determination.

ISSUE 3: HOW SHOULD DEBT ACQUIRED, BUT NOT ISSUED BY A RAILWAY COMPANY BE TREATED?

[147] During the calculation of CN’s 2020-2021 crop year cost of capital for western grain, the Agency became aware that CN has been reporting its BC Rail notes at their discounted value rather than at their book value, which is not consistent with the methodology required by the 2017 Determination. Due to the special nature of these BC Rail notes, CN asked for permission to record the notes at their market value for the purposes of the cost of capital calculation.

Consultation feedback

[148] CN submits that before it acquired BC Rail in 2004, BC Rail owed $1.7 billion to its parent company (British Columbia Railway Company), which exceeded the value of its assets. Before the acquisition, all the various BC Rail debts were consolidated into two debts:

• $842 million in debt to be repaid within 90 years with 0% interest; and
• Demand notes with balances that were repaid/retired by the CN acquisition.

[149] CN submits that it acquired BC Rail through a share purchase (transferring BC Rail assets and liabilities to CN). When this acquisition closed, CN recorded the 90-year debt at the discounted value of $5 million, which was the assessed market value in accordance with U.S. GAAP.

[150] CN argues that the methodology set by the Agency in the 2017 Determination may apply to typical debts issued with interest payments and relatively small discounts or premiums. CN indicates its typical debt discount is less than one percent, for example. However, the exceptional nature of the BC Rail notes warrants special consideration because these notes bear no interest, have an extremely long term, and were not issued by CN for any financial purpose, nor by BC Rail to finance rail operations. CN argues that the obligation must be presented at the discount value of the debt with an imputed interest rate of 5.75% for CN to earn sufficient revenue to meet this debt obligation.

[151] CP suggests that debt that is issued by a company other than a Class-I railway should not be included in the determination of the cost of capital at all. CN does not agree, arguing that not accounting for the debt, while at the same time consolidating the acquired company’s assets, would unjustly increase shareholders’ equity.

[152] CP argues that when a Class-I railway company acquires a small carrier, any debt items acquired would exhibit higher interest rates that are not representative of the Class-I railway company’s cost of debt. CN submits that the higher interest rates of a smaller carrier need to be reflected in the cost of capital, so that the company acquiring the smaller carrier can meet the debt obligation.

[153] Dr. Gould agrees that the acquisition of another railway and its debt is an abnormal situation. He argues that there is no reason why debt obtained through an acquisition should be treated differently from debt obtained through the issuance of bonds.

[154] Dr. Gould explains that the market value of debt can differ from its face value, and that this can also occur when debt is obtained through a railway company’s acquisition of another railway company. He submits that, as long as market value is determined correctly, the unamortized discounts and unamortized premiums on bonds payable could be used together with the face value of long-term debt for the purpose of the capital structure determination. Unamortized bond discounts would reduce long-term debt, while premiums would increase it. Reported interest would be the required market yield at issuance.

Analysis and determination

[155] Debt from an acquired railway company must be included in the Agency’s cost of capital assessment. This type of debt constitutes real financial obligations on the railway company based on its acquisition of real rail assets. As a result, the Agency considers these debts to be part of rail costs which must be included in the calculation of the cost of capital unless the railway company can demonstrate otherwise. The Agency will consider requests for special treatment of these debts on a case-by-case basis.

[156] In the case of CN’s BC Rail notes, the Agency accepts that its methodology does not appropriately reflect the full financing cost to CN for this obligation.

[157] In the 2011 Decision, the Agency determined that debt should be recorded at its coupon rate—the interest rate that a bond issuer is obligated to pay to the bondholder each year until maturity relative to the face value of the bond. In its simplest form, it is expressed as a ratio of the annual coupon payment to the bond’s face value. The Agency generally considers the coupon rate method to be the most reasonable and reliable method for measuring the yield on long-term debt to reflect the actual financing cost of existing debt.

[158] In the 2017 Determination, the Agency determined that long-term debt should be recorded at its face value, to conform to the long-standing definitions of assets and liabilities, and to conform to the 2011 Decision regarding determination of the cost of debt rate.

[159] Currently, all discounts on debt are to be recorded as a non-current asset in UCA account 35—Deferred Charges, as directed in the 2017 Determination. While this reduces long-term debt, UCA account 35 is not a cost account in the Agency’s costing model. As a result, no allowance is made for the cost of financing the discount, so that the railway companies can pay the debt when it becomes due.

[160] The Agency finds that its current methodology remains appropriate because the small discount amounts that typically apply, as referenced in CN’s submissions, would be unlikely to change final cost determinations, depending on the number of years chosen to amortize the discount.

[161] However, the Agency accepts that its methodology does not appropriately reflect CN’s full cost to finance the debt. In this case, the BC Rail notes do not bear any interest, and the 99 percent discount leads to a considerably different understanding of the nature of this debt, as compared with typical debts issued by the railway companies.

[162] Ordinarily, the cost to repay the BC Rail notes debt would be reflected in the Agency’s costing methodology as an ongoing annualized operating cost instead of a cost of capital. This is mainly because it was not a debt issued by CN to finance rail assets, but a cost taken on when it acquired BC Rail.

[163] Creating a new unit cost for UCA account 35 could avoid any impact on the annual cost of capital determination. However, if the Agency included this discount under UCA account 35, it would only apply to cost determinations under Division IV of the CTA, and notably would not include any additional allowance or charges for western grain transported under the MRE program. As that program represents an important part of regulated rail services, the Agency wants to ensure that traffic moved under this program is afforded the same treatment as all other regulated traffic.

[164] For these reasons, the Agency accepts CN’s proposed treatment of the BC Rail notes at market value and at an imputed interest rate of 5.75 percent in order for CN to meet this obligation. The inclusion of an allowance in the cost of capital in this circumstance is the most reasonable way to allow this recovery for regulatory purposes.

[165] All other debts will continue to be treated as stipulated in the 2011 Decision and 2017 Determination.

ISSUE 4: SHOULD A NEGATIVE WORKING CAPITAL BE ALLOWED IN THE CALCULATION OF NET RAIL INVESTMENT?

[166] Net rail investment includes an allowance for working capital, which is the cash, materials and supplies required by a railway company to maintain its day-to-day operations, such as paying wages, and to pay its accounts payable or to repay short‑term debt that is due.

[167] The Agency prescribed the current methodology to calculate the working capital allowance in the 2017 Determination. The working capital allowance is calculated by taking the average of 12 monthly estimates, where each monthly estimate is the average of the beginning and closing monthly balances of current assets, less the average of the beginning and closing monthly balance of current liabilities.

[168] In recent years, this methodology has produced a negative working capital for CN, which reduces CN’s net rail investment.

Consultation feedback

[169] Both CN and CP submit that a negative working capital is an inaccurate reflection of their actual financial obligations and does not provide a reasonable cost of capital for regulated rail purposes. They agree that any railway company needs working capital for its daily activities, and that a negative working capital allowance implies that the company does not require free cash despite the fact that it cannot collect from its customers before paying for the inputs required in providing railway services.

[170] CN submits that a regulatory balance sheet that includes negative working capital as one of its inputs must be investigated and that the balance sheet must be readjusted to align with the company’s financial health.

[171] CN states that it holds significant amounts of commercial paper, which CN often elects to rollover, as it is economically “cost efficient” for CN. It submits that its commercial paper is currently recorded as a short-term liability in accordance with the UCA, which gives the impression that CN’s current liabilities exceed its current assets, resulting in a negative working capital.

[172] Dr. Gould observes that the negative working capital issue would be resolved if the Agency adopted a lead-lag study approach. He points out that the Agency recognized that a lead-lag study was the most accurate approach for estimating working capital, but that the Agency found in the 2017 Determination that the financial burden on the railway companies outweighed the benefits of using this approach.

[173] Dr. Gould argues that, while a positive or negative working capital may be vital from a managerial or investment decision perspective (companies vary in their working capital and short-term financing policies, and financial analysts use various ratios to measure the liquidity of a company), liquidity is not relevant for the Agency’s determination of the cost of capital nor for the calculation of net rail investment.

Analysis and determination

[174] The Agency accepts that the 2017 Determination put in place an accounting approach which, in certain circumstances, may not produce results for the working capital calculation that match the economic reality of the railway companies for cost of capital purposes. A negative working capital is not reflective of the railway operations of a solvent railway company where the company pays for materials and supplies before receiving payment from its customers for services rendered.

[175] The Agency accepts CN’s submission that its negative working capital result is mainly because it holds significant amounts of commercial paper which are routinely refinanced as a cost-efficient method of financing CN’s operations.

[176] Commercial paper is a financial security instrument that is issued by large entities to obtain funds to meet their short-term financial obligations such as payroll or accounts payable. It will typically have a fixed maturity of less than one year and is only backed by the issuing company’s promise to pay the face amount on the maturity date specified on the paper. As commercial paper is currently recorded as a short-term liability in accordance with the UCA, this has caused CN’s current liabilities to exceed current assets, resulting in a negative working capital.

[177] A negative working capital reduces the railway company’s net rail investment, which must lead to a reduction in the sources of funds used in financing. The impact of this reduction is to change the weighting of the various cost rates in the final cost of capital rate even though the actual cost rates to finance the existing net rail investment (not including working capital) have not changed. In practical terms, this would lead to a reduction in the weighting of equity.

[178] In CN’s case, it is evident that the negative working capital was caused by the use of commercial paper as a long-term financial instrument. The issue of whether commercial paper should be included in working capital will be addressed below.

[179] In any case where a negative working capital occurs, the Agency will examine the details, determine whether the situation correctly leads to a negative working capital, and make any required adjustments on a case-by-case basis.

ISSUE 5: SHOULD COMMERCIAL PAPER BE INCLUDED IN THE CALCULATION OF WORKING CAPITAL?

[180] In the time since the Agency issued the 2017 Determination, the main driver of negative balances in the calculation of the working capital allowance has been the inclusion of very large balances of commercial paper, which are classified as current liabilities under the UCA because they come due in less than one year. According to the Agency’s cost of capital methodology, an increase in the use of commercial paper will reduce the amount of working capital available to the railway company.

[181] Although commercial paper is a short-term obligation, it may also form part of longer “rolling” programs that involve paying off maturing commercial paper with newly issued commercial paper for the remaining amount of the obligation. Thus, it is possible for commercial paper to have duration periods similar to those of long-term debt, which is defined as debt that becomes due in more than one year.

Consultation feedback

[182] Based on the submissions of CN and CP, it is apparent that the two railway companies have different strategies for the issuance of commercial paper. CN submits that it holds significant amounts of commercial paper and that, while it could convert some of it into long-term debt, it takes advantage of lower interest rates by continually refinancing its commercial paper. CP submits it uses commercial paper to meet short-term liquidity requirements, only when funds from operations and other sources are not immediately available.

[183] CN acknowledges that, as a consequence of its financing strategy, its regulatory balance sheet shows a negative working capital because the debt is presented as a current liability. However, CN submits that this does not represent its economic reality for cost of capital purposes.

[184] CN points out that U.S. GAAP allow a company to present short-term instruments as long-term debt if it demonstrates the intent and ability to refinance these instruments on a long-term basis. CN refers to its past financial history as proof that it meets these conditions, and argues that it should therefore be permitted to present its commercial paper as long-term debt and exclude it from the working capital calculation.

[185] CP claims that CPRL uses commercial paper for treasury purposes to provide short-term liquidity for corporate activities, and not to finance rail services as defined by UCA 1201. CP argues that commercial paper should be excluded from the regulatory balance sheet, but that if it is to be included, then it should be presented as a current liability because it represents a reduction in the company’s access to liquidity.

[186] CP argues that, even though commercial paper can be renewed, it is not transformed into a long-term debt obligation because it still has short-term rights and obligations attached to it. As cash is a fungible commodity, it would be impossible to distinguish between commercial paper that is being renewed, commercial paper that is being retired, and new commercial paper in a similar amount that is issued for a new purpose.

[187] CP observes that the UCA currently does not provide any direction regarding adjustments to commercial paper accounts, but that UCA account 49 does specify that obligations due on demand or within one year be classified as current liabilities.

[188] CN acknowledges that its use of commercial paper differs from that of CP and recommends allowing each railway company to choose how it reports commercial paper. CN submits that commercial paper is just another source of funds that enters a common pool that can be used to finance its activities. It argues that the Agency should allow the railway companies to treat all their commercial paper as either a current liability or long-term debt, as permitted by U.S. GAAP.

[189] Dr. Gould submits that commercial paper is a short-term liability and that there is no certainty that a company will continue to refinance this short-term liability as a long‑term financing tool. He compares the practice of refinancing a financial instrument to an individual paying their credit card balance by using an advance on another credit card. He has concerns as to whether this practice is sustainable.

[190] Regarding the sustainability of its financing strategy, CN observes that it did not need its cash reserves to cover commercial paper positions during the COVID-19 pandemic nor during the 2008 financial crisis, and that it was still able to access the commercial paper market during both time periods.

[191] Dr. Gould submits that, if the Agency decides to include the portion of commercial paper that is continuously refinanced under long-term debt, then the railway companies should be required to demonstrate, with the appropriate paperwork, that it has been refinanced.

[192] Dr. Gould submits the following with respect to other short-term financial instruments:

• A line of credit is a current liability because its underlying nature is based on a one-year agreement or less (similar to commercial paper);

• A revolving line of credit is the same as a line of credit, except that the bank extends the commitment for a longer period of time. Although the commitment is longer than one year, its use as short-term financing qualifies it as a current liability; and

• Accounts receivable securitization programs provide a company with short‑term financing by selling ownership in a revolving pool of its accounts receivable (a current asset).

[193] Although the stakeholders disagree on how to classify short-term financial tools, they all agree that they should all be treated in a consistent manner, as a category.

Analysis and determination

[194] The Agency has always considered working capital to be rail-related. While the majority of the net rail investment consists of long-term rail assets such as track and equipment, it also includes the working capital allowance, comprised of the cash, materials and supplies required by the company to maintain day-to-day operations. The Agency’s current methodology to calculate working capital reflects only the portion of materials and supplies financed by the railway companies’ investors.

[195] However, if the railway companies are using commercial paper or other short-term financial instruments to fund their day-to-day operations, these instruments should be included in the cost of capital calculation, as they represent a reduction to the working capital financed by investors. On the other hand, if these instruments are used to finance long-term rail assets, then categorizing them as current liabilities does not capture the actual interest rate paid by the railway companies to fund these assets.

[196] Both CN and CP have stated that the railway companies treat cash as fungible, in that they place it in a common pool of funds from which their divisions can make withdrawals for any purpose.

[197] The Agency finds, based on the evidence from this consultation, that commercial paper and other short-term financial instruments are used for rail-related purposes. As a railway company, CP’s immediate cash needs are clearly rail-related, and cost of capital is applied to this cash balance. The Agency will therefore consider commercial paper and all other short-term financial instruments in the calculation of cost of capital.

[198] The Agency recognizes the difficulties in determining whether commercial paper is renewed, retired or newly issued. Because of this, the Agency will allow the railway companies to elect whether to treat their short-term financial instruments, including commercial paper as either a current liability or long-term debt, as long as they meet the relevant requirements of U.S. GAAP. The Agency finds that opting to file short-term liabilities such as commercial paper as long-term debt is consistent with the direction given in section 1202.01 of the UCA because the filing would, in fact, be in accordance with U.S. GAAP.

[199] If a railway company chooses to identify short-term financial instruments as long-term debt, the Agency directs the company to demonstrate in writing that it intends to continue to use these financial instruments as long-term debt, in accordance with section 45-14 of U.S. GAAP, as amended from time to time. The current version of this section is presented in Appendix B for the convenience of readers.

ISSUE 6: SHOULD THE CURRENT PORTION OF LONG-TERM DEBT BE IDENTIFIED AS A CURRENT LIABILITY OR AS LONG-TERM DEBT?

[200] The Agency considers the current portion of long-term debt to be the amount of unpaid principal from long-term debt that accrues in a company’s normal operating cycle (typically less than 12 months). It is considered a current liability because it has to be paid within that period. Under the Agency’s regulatory costing model, the principal is paid through depreciation or amortization charges.

[201] The Agency takes the same approach when railway companies have a portion of debt that is due within the year, but is refinanced and rolled over instead of repaid at the end of its term. U.S. GAAP, on the other hand, allow a company to classify the current portion of long-term debt as long-term debt if it indicates that it intends, and is able, to refinance the instruments in question.

Consultation feedback

[202] CN believes that the current portion of long-term debt should be classified as long-term debt to accurately present its capital structure. CN states that its long-term debt has been growing year over year because it has been continuously refinanced. Using an example of a bond renewed each time it reaches maturity, CN shows that treating the current portion of long-term debt as a current liability distorts the capital structure of a company. In the year that the bond reaches maturity, it is classified as equity, resulting in a fluctuation in the company’s equity at the same time as the company continues to make interest payments on the bond.

[203] CP submits that the current portion of long-term debt is properly treated as a current liability, based on U.S. GAAP and section 1701-57 of the UCA. CP argues that it represents a claim on current assets (cash) and, thus, reduces the amount of working capital available to a company.

[204] Dr. Gould argues that the Agency should classify the current portion of long-term debt as part of long-term debt when calculating the cost of capital. He states that accountants classify the current portion of long-term debt as part of current liabilities to determine whether a company has enough liquidity to pay off short-term obligations. He argues, however, that this is not a relevant concern when measuring capital structure for the calculation of cost of capital. He submits that a bond should be considered as long-term debt for the entire length of its term to ensure consistency, and to allow for the most accurate calculation of the rates for long-term debt and the overall cost of capital.

Analysis and determination

[205] The Agency strives to be as accurate as possible in calculating long-term debt obligations and working capital. If the current portion of long-term debt is not included in the calculation of the sources of capital, it could lead to a cost of capital that does not reflect the actual cost of financing the railway company’s net rail investment. Under the existing methodology, the current portion of long-term debt is considered to be a current liability, thus reducing the working capital allowance and decreasing net rail investment. These accounting rules assume that railway companies will fully repay debts at maturity, rather than refinance those debts.

[206] However, a railway company may consider the current portion of long-term debt to be part of the long-term debt. Because long-term debt rates have been historically low for most of the past decade, this is a common approach used to maintain or enhance cash flow for current operations. According to U.S. GAAP special rules presented in Appendix B, this treatment can be used if an entity has the intent and the ability to refinance those debt instruments on a long-term basis.

[207] If the current portion of long-term debt was classified as long-term debt, it would impact the Agency’s calculation of the cost of capital as follows:

• the interest rate of the long-term debt would be factored into the weighted average cost of debt in the final year;
• its inclusion would increase the value of long-term debt in the capital structure; and
• its inclusion would also increase the value of net rail investment, because the current portion of the long-term debt would be removed from current liabilities, increasing the working capital allowance.

[208] If a long-term debt is refinanced, then classifying the current portion of long-term debt as part of long-term debt would allow for the calculation of the correct interest allowance, and no assumed draw down on current assets would occur.

[209] This outcome is consistent with the railway companies’ financial requirements because the refinancing means that there is no need to repay the principal from current assets, and that the debt payments and the size of the debt will continue going forward. Consequently, the Agency accepts that if long-term debt is refinanced, the Agency’s requirement to treat the current portion of long-term debt as a current liability could result in a cost of capital that may not provide a reasonable return to investors.

[210] For these reasons, the Agency will give the railway companies the option to treat the current portion of their long-term debt as either a current liability or a long-term debt in accordance with U.S. GAAP special rules, as amended from time to time. See Appendix B for the current version of these special rules.

[211] This will allow for the proper calculation of the railway company’s long-term debt obligation if it is refinanced, and the proper calculation of the railway company’s claim on current assets if it is not refinanced.

REVIEW OF CN’S AND CP’S REGULATORY BALANCE SHEETS

[212] To ensure the alignment of regulatory reporting with this determination, the Agency will perform a detailed review of CN’s and CP’s regulatory balance sheet accounts and consolidating entries to the consolidated balance sheets beginning in the summer of 2022.

UCA AMENDMENT

[213] To clarify the Agency’s interpretive approach to the UCA and the railway companies’ obligations when interpreting the UCA or implementing changes in reporting, the Agency amends, effective as of the date of Determination R-2022-16, section 1104.01 of the UCA to read as follows:

1104.01 The provisions of the UCA must be read in light of the regulatory costing purpose, as set out in section 1201. When in doubt, or before implementing a change in reporting under the UCA, carriers shall seek interpretation or clarification of the provisions(s) through the Secretary of the Agency. In addition, the Agency may issue interpretations on its own initiative.

[214] In the interests of transparency for all stakeholders, substantive questions that arise in relation to the interpretation of the UCA will continue to be addressed through public consultations.

BILATERAL CONSULTATIONS

[215] The Agency dismisses CP’s request for confidential bilateral consultations on the implementation of this determination as they are unnecessary at this time. This does not prevent either CP or CN from approaching the Agency with questions respecting the calculation of cost of capital.

SECTION 32

[216] The Agency indicated in Decision LET-R-34-2021 and Decision LET-R-35-2021 that it would conduct a review of CP’s and CN’s cost of capital determinations for the 2021‑2022 crop year pursuant to section 32 of the CTA if the outcome of these consultations resulted in a new reporting standard that would lead to materially different results in the determination of their cost of capital.

[217] The Agency finds that this determination does not simply result in a new reporting standard for CN and CP. Instead, as a result of these consultations, the Agency has established a new methodological approach to calculating the railway companies’ capital structure for regulatory purposes. The Agency recognizes that this new methodological approach is a departure from past reporting and that adaptation by CN and CP will be required.

[218] The Agency has discretion both with respect to the timing of implementation of its decisions and with respect to the use of section 32. In light of the adaptations that will be required to implement the new methodology, the Agency finds that this determination will be applied to the upcoming 2022-2023 crop year. For the same reason, the Agency will not initiate a proceeding on its own motion to determine whether the new methodology constitutes a new fact or circumstance warranting a review of the 2021-2022 crop year cost of capital determinations.

ORDER

[219] The Agency orders CN and CP:

• to submit their estimated cost of capital rate and the inputs used to derive this estimated rate by March 1^st of each year; and
• to provide the Agency with additional information upon request.

 

---

APPENDIX A TO DETERMINATION NO. R-2022-39

Consolidated Balance Sheet Methodology

CP 2020 Annual Report, Consolidated Balance Sheets, Page 105

As at December 31 (in millions of Canadian dollars, except Common Shares)	2020	2019	Capital Structure for Agency Cost of Capital Determinations
Assets
Current Assets
Cash and cash equivalents	147	133
Accounts receivable, net	825	805
Materials and supplies	208	182
Other current assets	141	90
Total Current Assets	1,321	1,210	Working Capital
Investments	199	341
Properties	20,422	19,156
Goodwill and intangible assets	366	206
Pension asset	894	1,003
Other assets	438 Note 1	451 Note 1
Total assets	23,640 Note 1	22,367 Note 1	Net Rail Investment
Liabilities and shareholders’ equity
Current liabilities
Accounts payable and accrued liabilities	1,467	1,693
Long-term debt maturing within one year	1,186	599
Total Current Liabilities	2,653	2,292	Working Capital
Pension and other benefit liabilities	832	785	Future Income Taxes and Investment Tax Credits
Other long-term liabilities	585 Note 2	562 Note 2	See note 18
Long-term debt	8,585 Note 3	8,158 Note 3	Long-term debt
Deferred income taxes	3,666	3,501	Future Income Taxes and Investment Tax Credits
Total liabilities	16,321 Note 2 Note 3	15,298 Note 2 Note 3
Shareholders’ equity
Share capital Authorized unlimited Common Shares without par value. Issued and outstanding are 133.3 million and 137.0 million as at December 31, 2020 and 2019, respectively.	1,983	1,993
Authorized unlimited number of first and second preferred shares; none outstanding.
Additional paid-in capital	55	48
Accumulated other comprehensive loss	(2,814)	(2,522)
Retained earnings	8,095	7,550
Total shareholders’ equity	7,319	7,069	Common Equity
Total liabilities and shareholders’ equity	23,640 Note 2 Note 3	22,367 Note 2 Note 3

Note 18 – Other long-term liabilities, CP 2020 Annual Report, Page 129

(in millions of Canadian dollars)	2020	2019	Capital Structure for Agency Cost of Capital Determinations
Operating lease liabilities, net of current portion	248	285	Long-term debt
Stock-based compensation liabilities, net of current portion	146	111	Future Income Taxes and Investment Tax Credits
Provision for environmental remediation, net of current portion	71	70	Future Income Taxes and Investment Tax Credits
Deferred revenue, net of current portion	34	4	Future Income Taxes and Investment Tax Credits
Deferred real estate lease and license revenue, net of current portion	18	20	Future Income Taxes and Investment Tax Credits
Deferred gains on sale leaseback transactions	5	6	Future Income Taxes and Investment Tax Credits
Other, net of current portion	63	66	Future Income Taxes and Investment Tax Credits
Total other long-term liabilities	585	562

CN 2020 Annual Report, Consolidated Balance Sheets, Page 63

As at December 31 (in millions of Canadian dollars)	2020	2019	Capital Structure for Agency Cost of Capital Determinations
Assets
Current Assets
Cash and cash equivalents	569	64
Restricted cash and cash equivalents	531	524
Accounts receivable	1,054	1,213
Material and supplies	583	611
Other current assets	365	418
Total Current Assets	3,102	2,830	Working Capital
Properties	40,069	39,669
Operating lease right-of-use assets	435	520
Pension asset	777	336
Intangible assets, goodwill and other	421 Note 1	429 Note 1
Total assets	44,804 Note 1	43,784 Note 1	Net Rail Investment
Liabilities and shareholders’ equity
Current liabilities
Accounts payable and other	2,364	2,357
Current portion of long-term debt	910	1,930
Total Current Liabilities	3,274	4,287	Working Capital
Deferred income taxes	8,271	7,844	Future Income Taxes and Investment Tax Credits
Other liabilities and deferred credits	534 Note 2	634 Note 2	Future Income Taxes and Investment Tax Credits
Pension and other postretirement benefits	767	733	Future Income Taxes and Investment Tax Credits
Long-term debt	11,996Note 3	11,866Note 3	Long-term debt
Operating lease liabilities	311	379	Long-term debt
Shareholders’ equity
Common shares	3,698	3,650
Common shares in Share Trusts	(115)	(163)
Additional paid-in capital	379	403
Accumulated other comprehensive loss	(3,472)	(3,483)
Retained earnings	19,161	17,634
Total shareholders’ equity	19,651	18,041	Common Equity
Total liabilities and shareholders’ equity	44,804	43,784

APPENDIX B TO DETERMINATION NO. R-2022-39

FASB ASC 470 (extract)  

Short-Term Obligations Expected to Be Refinanced

45-12A

Some short-term obligations are expected to be refinanced on a long-term basis and, therefore, are not expected to require the use of working capital during the ensuing fiscal year. Examples include commercial paper, construction loans, and the currently maturing portion of long-term debt.­ [Emphasis added]

45-12B

Refinancing a short-term obligation on a long-term basis means either replacing it with a long-term obligation or with equity securities or renewing, extending, or replacing it with short-term obligations for an uninterrupted period extending beyond one year (or the operating cycle, if applicable) from the date of an entity's balance sheet. [Emphasis added]

45-13

Short-term obligations arising from transactions in the normal course of business that are due in customary terms shall be classified as current liabilities. A short-term obligation shall be excluded from current liabilities only if the conditions in the following paragraph are met. Funds obtained on a long-term basis before the balance sheet date would be excluded from current assets if the obligation to be liquidated is excluded from current liabilities.

Intent and Ability to Refinance on a Long-Term Basis

45-14

A short-term obligation shall be excluded from current liabilities if the entity intends to refinance the obligation on a long-term basis (see paragraph 470-10-45-12B) and the intent to refinance the short-term obligation on a long-term basis is supported by an ability to consummate the refinancing demonstrated in either of the following ways:

a. Post-balance-sheet-date issuance of a long-term obligation or equity securities. After the date of an entity's balance sheet but before that balance sheet is issued or is available to be issued (as discussed in Section 855-10-25), a long‑term obligation or equity securities have been issued for the purpose of refinancing the short-term obligation on a long-term basis. If equity securities have been issued, the short-term obligation, although excluded from current liabilities, shall not be included in owners' equity.

b.Financing agreement. Before the balance sheet is issued or is available to be issued (as discussed in Section 855-10-25), the entity has entered into a financing agreement that clearly permits the entity to refinance the short-term obligation on a long-term basis on terms that are readily determinable, and all of the following conditions are met:

1. The agreement does not expire within one year (or operating cycle) from the date of the entity's balance sheet and during that period the agreement is not cancelable by the lender or the prospective lender or investor (and obligations incurred under the agreement are not callable during that period) except for violation of a provision with which compliance is objectively determinable or measurable. For purposes of this Subtopic, violation of a provision means failure to meet a condition set forth in the agreement or breach or violation of a provision such as a restrictive covenant, representation, or warranty, whether or not a grace period is allowed or the lender is required to give notice. Financing agreements cancelable for violation of a provision that can be evaluated differently by the parties to the agreement (such as a material adverse change or failure to maintain satisfactory operations) do not comply with this condition.

2. No violation of any provision in the financing agreement exists at the balance sheet date and no available information indicates that a violation has occurred thereafter but before the balance sheet is issued or is available to be issued (as discussed in Section 855-10-25), or, if one exists at the balance sheet date or has occurred thereafter, a waiver has been obtained.

3. The lender or the prospective lender or investor with which the entity has entered into the financing agreement is expected to be financially capable of honoring the agreement. [Emphasis added]

45-15

Repayment of a short-term obligation before funds are obtained through a long-term refinancing requires the use of current assets. Therefore, if a short-term obligation is repaid after the balance sheet date and subsequently a long-term obligation or equity securities are issued whose proceeds are used to replenish current assets before the balance sheet is issued or is available to be issued (as discussed in Section 855-10-25), the short-term obligation shall not be excluded from current liabilities at the balance sheet date. See Example 5 (paragraph 470-10-55-33) for an illustration of this guidance.

45-16

If an entity's ability to consummate an intended refinancing of a short-term obligation on a long-term basis is demonstrated by post-balance-sheet-date issuance of a long‑term obligation or equity securities (see paragraph 470-10-45-14(a)), the amount of the short-term obligation to be excluded from current liabilities shall not exceed the proceeds of the new long-term obligation or the equity securities issued.

45-17

If ability to refinance is demonstrated by the existence of a financing agreement (see paragraph 470-10-45-14(b)), the amount of the short-term obligation to be excluded from current liabilities shall be reduced to the amount available for refinancing under the agreement if the amount available is less than the amount of the short-term obligation.

45-18

The amount to be excluded shall be reduced further if information (such as restrictions in other agreements or restrictions as to transferability of funds) indicates that funds obtainable under the agreement will not be available to liquidate the short-term obligation.

45-19

Further, if amounts that could be obtained under the financing agreement fluctuate (for example, in relation to the entity's needs, in proportion to the value of collateral, or in accordance with other terms of the agreement), the amount to be excluded from current liabilities shall be limited to a reasonable estimate of the minimum amount expected to be available at any date from the scheduled maturity of the short-term

obligation to the end of the fiscal year (or operating cycle). If no reasonable estimate can be made, the entire outstanding short-term obligation shall be included in current liabilities.

45-20

The entity may intend to seek an alternative source of financing rather than to exercise its rights under the existing agreement when the short-term obligation becomes due. The entity must intend to exercise its rights under the existing agreement, however, if that other source does not become available. The intent to exercise may not be present if the terms of the agreement contain conditions or permit the prospective lender or investor to establish conditions, such as interest rates or collateral requirements, that are unreasonable to the entity.
 

APPENDIX C TO DETERMINATION NO. R-2022-39

Table 1: CP capital structure as reported in its 2007 Annual Report vs. its 2007 Agency report

CP 2007

	Consolidated Reporting	Agency Reporting
Long-term debt	34,5 %	[Redacted]
Deferred liabilities	20,1 %	[Redacted]
Equity	45,4 %	[Redacted]

Table 2: CP capital structure as reported in its 2020 Annual Report vs. its 2020 Agency report

CP 2020

	Consolidated Reporting	Agency Reporting
Long-term debt	40,9 %	[Redacted]
Deferred liabilities	24,2 %	[Redacted]
Equity	34,9 %	[Redacted]