Audit of Offshore Revenues and Transfers (AU1420)
TABLE OF CONTENTS
EXECUTIVE SUMMARY
INTRODUCTION
On behalf of Canada, Natural Resources Canada (NRCan) receives revenues and makes transfer payments to the provinces of Nova Scotia and Newfoundland and Labrador related to offshore oil and gas operations in these provinces. These revenue and transfer streams include:
- Royalty payments, corporate income tax, and forfeitures for which Canada receives amounts and transfers equivalent amounts to the provinces;
- Crown share adjustment payments representing transfers from Canada to Nova Scotia; and
- Net profits interest and incidental net profits interest revenues received and retained by Canada.
Administration of offshore revenues and transfers involves activities undertaken by the Energy Sector and the Corporate Management and Services Sector within NRCan.
NRCan’s obligations related to these revenue and transfer streams are governed by the Canada-Newfoundland Atlantic Accord Implementation Act and Canada-Nova Scotia Offshore Petroleum Resources Accord Implementation Act (Accord Acts) and supporting regulations. Each of the revenue and transfer streams has unique administrative requirements in comparison to other NRCan transfer programs.
The audit of Offshore Revenues and Transfers was approved by the Deputy Minister on April 26, 2013 as part of the Department’s Risk-Based Audit Plan.
The objective of the audit is to provide reasonable assurance that NRCan has a management control framework in place to effectively administer and manage offshore revenues and transfers.
The scope of the audit included the following revenue and transfer payment streams for Nova Scotia and Newfoundland and Labrador for the fiscal years 2010-14: Offshore Royalties and Transfers; Corporate Income Tax Transfers; Forfeiture Receipts and Transfers; Crown Share Adjustment Payments; Net Profits Interest (NPI) Receipts; and Incidental Net Profits Interest (INPI) Receipts.
STRENGTHS
For fiscal years 2010-14, the Department processed approximately $4.8 billion in offshore revenues and transfer payments to the provinces of Newfoundland and Labrador and Nova Scotia. Based on the audit work conducted, the Department has accurately processed receipts and made transfers to the provinces on a timely basis. Overall, the Department has established an effective management control framework to support the exercise of its administrative requirements and obligations in relation to the various offshore revenue and transfer streams.
AREAS FOR IMPROVEMENT
Opportunities for improvement were identified in the following areas:
- Formal clarification of the respective roles, responsibilities and obligations between the Department and Canada Revenue Agency in administering the collection, assessment and transfer of corporate income taxes to the provinces;
- Enhancing the existing business process and internal control documentation to address the full scope of processes and activities undertaken within the Energy Sector and Corporate Management and Services Sector related to offshore revenue and transfer administration and oversight;
- Completing the implementation of a comprehensive risk-based audit approach related to the NPI and INPI revenues received and retained by Canada; and
- Engagement of provincial representatives to define opportunities for information sharing to better inform NRCan revenue and transfer payment forecasting assumptions.
AUDIT CONCLUSION AND OPINION
Overall, the Audit Branch can provide reasonable assurance that NRCan has an effective management control framework in place to administer and manage accurate and timely offshore royalty revenues and related transfers. Opportunities for improvement were identified related to implementing enhancements to the oversight of NPI/INPI revenues which would provide assurance on the accuracy and completeness of the amounts received; further clarifying and documenting select roles, responsibilities and processes, as well as exploring opportunities to work with external partners to better inform NRCan administrative processes.
STATEMENT OF CONFORMANCE
In my professional judgement as Chief Audit Executive, the audit conforms with the Internal Auditing Standards for the Government of Canada, as supported by the results of the internal Quality Assurance and Improvement Program.
Christian Asselin, CPA, CA, CMA, CFE
Chief Audit Executive
ACKNOWLEDGEMENTS
The audit team would like to thank those individuals who contributed to this project and, particularly employees who provided insights and comments as part of this audit.
INTRODUCTION
On behalf of Canada, NRCan receives revenues and makes transfer payments to the provinces of Nova Scotia & Newfoundland and Labrador related to offshore oil and gas operations in these provinces.
NRCan’s obligations are governed by the Canada-Newfoundland Atlantic Accord Implementation Act and Canada-Nova Scotia Offshore Petroleum Resources Accord Implementation Act (Accord Acts). These Acts were established in 1987 and 1988 respectively and provide definitions of what constitute revenues generated offshore, including royalties, forfeitures, and corporate income taxes. In addition, there are a number of other legislative guidance documents (e.g. regulations) governing the other elements of NRCan’s offshore revenue and transfer regime.
The offshore revenues and transfers administered by NRCan include the following elements for which revenues are received by the Government of Canada’s Receiver General of Canada before being transferred back to the provinces of Nova Scotia and/or Newfoundland and Labrador:
- Offshore Royalties – Pursuant to the Atlantic Accord Implementation Acts with Nova Scotia and Newfoundland and Labrador, royalty revenues are paid monthly by offshore license holders to the Receiver General into the Consolidated Revenue Fund (CRF) and, as requested by NRCan, an equivalent amount is then transferred monthly from the CRF to the respective provinces. The provinces obtain assurance relating to the accuracy and completeness of offshore royalties through their respective royalty audit processes.
- Corporate Income Tax – Pursuant to the Atlantic Accord Implementation Acts, upon Canada Revenue Agency (CRA) assessment and notification of taxes from offshore oil and gas companies, NRCan transfers like amounts to the Provinces of Newfoundland and Labrador, and Nova Scotia. Oversight relating to the accuracy and completeness of Corporate Income Taxes is provided through the assessment practices of the Canada Revenue Agency.
- Forfeitures – Pursuant to the Atlantic Accord Implementation Acts, NRCan receives forfeitures from license holders via the boards and transfers equivalent amounts to Newfoundland and Labrador and Nova Scotia. Forfeitures arise when a company has failed to meet the conditions of a license (e.g. drilling) within a specified period and therefore forfeits an amount previously deposited or given as a guarantee. In most instances, the license holder will issue a payment to the Receiver General resulting in the guarantee being released. Forfeiture amounts represent a minor component of overall offshore revenues (see table below). Oversight relating to the accuracy and completeness of forfeiture amounts assessed is provided through the administrative practices of the respective federal/provincial offshore petroleum boards.
One of the transfer streams involves the transfer of amounts to Nova Scotia for which there is no corresponding revenue to Canada:
- Crown Share Adjustment Payments – Pursuant to the Crown Share Adjustment Payments Regulations, on an annual basis, Canada transfers an amount to Nova Scotia representing 75% of the notional profits that the province would have earned from an offshore oil and gas project, had it been able to acquire a Crown Share interest. The completeness and accuracy of royalty amounts used to derive Crown Share Adjustment Payments are subject to the offshore royalty audit processes of the Province of Nova Scotia.
In addition, the following elements are administered by NRCan and represent revenues where the Government of Canada is the beneficiary of amounts collected:
- Net Profits Interest (NPI) – Pursuant to the Hibernia Development Project Net Profits Interest Agreement, the Receiver General receives monthly revenues from certain Hibernia licenses on behalf of the Government of Canada. These amounts are calculated based on a 10% share of Hibernia oil profits (oil revenues generated by Hibernia license holders less their eligible expenses). The Receiver General deposits these funds into NRCan’s non-respendable revenue fund and these revenues are captured in NRCan’s financial statements.
- Incidental Net Profits Interest (INPI) – Pursuant to the Incidental Net Profits Interest Agreement, the Receiver General receives a 10% interest in the profits earned by the original Hibernia Development licence holders (the Project Owners) from the use of Hibernia facilities to produce hydrocarbons from new Hibernia projects (e.g. license holders for the Hibernia South Extension project). The Receiver General deposits these funds into NRCan’s non-respendable revenue fund and these revenues are captured in NRCan’s financial statements.
NRCan has recently initiated an audit program to assess the accuracy and completeness of NPI and INPI amounts collected to date.
Provided below is a summary of the financial considerations related to these revenue and transfer streams.
| Revenue/Transfer Element | 2010-2011 (SMM) |
2011-2012 (SMM) |
2012-2013 (SMM) |
|||
|---|---|---|---|---|---|---|
| Revenue | Transfer | Revenue | Transfer | Revenue | Transfer | |
| Inflow to Consolidated Revenue Fund (CRF) / Transfers to Provinces | ||||||
| Offshore Royalties | $1,180.0 | $1,180.0 | $1,147.1 | $1,147.1 | $540.9 | $540.9 |
| Corporate Income Tax* | $269.1 | $269.1 | $61.0 | $61.0 | $80.2 | $80.2 |
| Forfeitures | $3.8 | $3.8 | $8.9 | $8.9 | $0.1 | $0.1 |
| TOTAL | $1,452.9 | $1,452.9 | $1,217.0 | $1,217.0 | $621.2 | $621.2 |
| Transfers to Nova Scotia | ||||||
| Crown Share Adjustment Payments | N/A | $0.0 | N/A | $66.5 | N/A | $7.3 |
| TOTAL | N/A | $0.0 | N/A | $66.5 | N/A | $7.3 |
| Revenues into CRF | ||||||
| Net Profits Interest | $438.8 | N/A | $566.2 | N/A | $448.2 | N/A |
| Incidental Net Profits Interest | $0.0 | N/A | $0.4 | N/A | $0.1 | N/A |
| TOTAL | $438.8 | N/A | $566.6 | N/A | $448.3 | N/A |
* Corporate Income Tax revenues collected by CRA
Administration of these various offshore revenue and transfer streams involves activities undertaken by the Energy Sector and the Corporate Management and Services Sector. Appendix A provides an overview of these organizations and respective roles.
In addition to NRCan, there are several other organizations that provide varying levels of oversight related to the reporting of offshore oil and gas royalties and related amounts. They include the royalty audit functions of the provinces of Nova Scotia & Newfoundland and Labrador as well as their respective auditors general and the Auditor General of Canada through the audit of public accounts.
AUDIT PURPOSE AND OBJECTIVES
The objective of the audit is to provide reasonable assurance that NRCan has a management control framework in place to effectively administer and manage offshore revenues and transfers. In support of this objective, the audit assessed the extent to which:
- There is an effective governance structure in place for managing offshore revenues and transfers; and
- Effective internal controls exist to ensure accurate, complete and timely reporting of offshore revenue and transfers.
DEPARTMENTAL RISKS
A risk-based approach was used in establishing the objectives, scope and approach to this audit engagement. The amounts of the revenues and transfers involved represent an inherent risk due to their materiality. Furthermore, a summary of the other key underlying risks that were taken into consideration are:
Governance:
- Roles, responsibilities and accountabilities within NRCan and between NRCan and its key stakeholders may not be clearly defined, documented for each of the revenue and or transfer streams.
- Documentation and definitions of roles, responsibilities and accountabilities may not be well understood.
Internal Control:
- NRCan may not have a sufficient internal control framework to ensure that revenues and/or transfers under NRCan’s responsibility are completely and accurately collected and/or transferred and reported on a timely basis. (Note: The internal control framework includes controls related to the relevant activities of both the Program (i.e. Frontier Lands Management Division (FLMD) and Finance functions in relation to offshore revenues and transfers)).
- NRCan may not be receiving complete, consistent and timely information from interest holders to enable appropriate monitoring of reported revenues.
Risk Management:
- NRCan's approach to administering the various offshore oil and gas revenue and/or transfer elements may not appropriately integrate and leverage the internal controls verification work of its stakeholders.
SCOPE
The scope of the audit included the following revenue and transfer payment streams for Nova Scotia and Newfoundland and Labrador for the fiscal years 2010-14:
- Offshore Royalties and Transfers;
- Corporate Income Tax Transfers;
- Forfeiture Receipts and Transfers;
- Crown Share Adjustment Payments;
- Net Profits Interest Receipts; and
- Incidental Net Profits Interest Receipts.
The audit excluded the following:
- Interest Assistance Loan transactions;
- Equalization payments; and
- Provincial Petroleum Board budget funding.
APPROACH AND METHODOLOGY
The approach and methodology followed the Internal Auditing Standards for the Government of Canada, which incorporates the Institute of Internal Auditors’ International Standards for the Professional Practice of Internal Auditing. These standards require that the audit be planned and performed in such a way as to obtain reasonable assurance that audit objectives are achieved.
The audit included tests considered necessary to provide such assurance. Internal auditors performed the audit with independence and objectivity as defined by the Internal Auditing Standards for the Government of Canada.
The audit approach included the following key tasks:
- Reviewing applicable legislative and regulatory documentation related to offshore revenues and transfers;
- Reviewing key supporting documents and relevant background documentation;
- Conducting interviews with key NRCan stakeholders from Energy Sector, Finance and Procurement Branch related to the administration of offshore revenue and transfer processes;
- Conducting interviews with representatives from Canada Revenue Agency, Canada Hibernia Holding Corporation and the Provinces of Newfoundland and Labrador and Nova Scotia involved in offshore revenue and transfer processes;
- Analyzing and testing a sample of transactions for each revenue and transfer stream to assess transaction processing accuracy, timeliness and completeness; and
- Analyzing and testing the presentation of offshore revenue and transfer amounts included in the annual Departmental financial statements.
CRITERIA
Audit criteria are reasonable standards of performance and control that are used by the Audit Branch to assess the adequacy of offshore revenue and transfer management control framework. Actual performance was assessed against the audit criteria resulting in either a positive finding or the identification of an area of improvement.
The specific audit criteria can be found in Appendix – B.
FINDINGS AND RECOMMENDATIONS
Roles and Responsibilities
Summary Finding
The Department has established roles and responsibilities for administering offshore revenue and transfer processes. An opportunity for improvement was identified for NRCan to more clearly articulate and delineate its role and its expectations vis a vis Canada Revenue Agency (CRA) in the administration of CIT transfers.
Supporting Observations
Under the Accord Acts, Canada is responsible for collecting corporate income taxes, interest and penalties on taxable income from Nova Scotia and Newfoundland and Labrador offshore petroleum operations. Canada is further responsible for crediting these amounts to the respective provincial offshore resource revenue funds.
The Newfoundland Offshore Petroleum Resource Revenue Fund Regulations and the Nova Scotia Offshore Revenue Account Regulations (the regulations) prescribe the timing for crediting of the revenue funds and paying Corporate Income Tax amounts to the province.
Within this context, the Canada Revenue Agency, CRA, collects the Corporate Income Tax (CIT) amounts related to offshore operations are reported by interest holders on their respective corporate tax returns. Upon assessment or reassessment of these amounts, Canada Revenue Agency (CRA) informs NRCan who in turn transfers these amounts to the province.
As specified in the regulations, the provincial revenue fund must be credited within ten working days after the end of each month, with an amount equal to the aggregate of the following amounts assessed, reassessed or received, as the case may be, during the month. Furthermore, the province must be paid no later than the last working day of the month which the revenue fund was credited.
In order to meet the transfer timing requirements prescribed in the regulations, NRCan is reliant on CRA’s timely notification of offshore CIT amounts assessed. Currently, there is no formal measurement or confirmation of the timeliness of the combined CRA/NRCan process to ensure that CIT payments are made to the province on a timely basis.
Furthermore, the audit notes that there is currently no formal agreement in place between NRCan and CRA to articulate the respective roles, responsibilities and obligations of the organizations in relation to the administration of offshore CIT (e.g. CRA has CIT audit responsibility) and the mechanics of transferring CIT to the province. As a first step towards formalizing an agreement, the audit notes that FLMD representatives have recently contacted CRA representatives to initiate discussions.
A detailed review of available roles and responsibilities documentation, such as administrative process and control descriptions and the offshore revenue and transfer regulations, as well as interviews held with key stakeholders from NRCan, the CRA and the provinces involved in offshore revenue and transfer process, further highlighted the benefits of clarifying roles and responsibilities. Doing so would allow NRCan to more clearly delineate its role and its service level expectations of CRA in the administration of CIT transfers.
RISK AND IMPACT
The lack of formally documented roles and responsibilities between NRCan and CRA could result in a lack of clarity in NRCan’s performance expectations of CRA relating to the timely notification and transfer of CIT amounts to the provinces.
RECOMMENDATION 1
It is recommended that the Assistant Deputy Minister, Energy Sector initiate discussions with the Canada Revenue Agency to draft a formal agreement confirming the respective roles and responsibilities of each organization in relation to the administration of corporate income tax (CIT) transfers and the validation of CIT amounts reported by interest holder corporations.
MANAGEMENT RESPONSE, ACTION PLAN AND TIME FRAME
Management agrees. On March 24, 2014 Energy Sector (ES) initiated discussions with Canada Revenue Agency (CRA) by proposing a formal agreement confirming the respective roles and responsibilities of each organization in relation to the administration of CIT transfers and the validation of CIT amounts reported by interest holder corporations. CRA’s Federal Affairs Division has confirmed receipt of NRCan’s proposal and is reviewing the request. As a next step to complete the response to the recommendation, ES will provide CRA with a draft agreement for consideration.
Position responsible: Executive Director, Frontier Lands Management Division
Timing: June 30, 2014
Internal Controls – Administrative Process and Control Documentation
Summary Finding
Process documentation has been created to guide the administration of offshore revenue and transfers processes; however, there are several process elements that have not yet been as comprehensively documented. Process documentation gaps, combined with NRCan’s reliance on a small number of employees to administer offshore revenue and transfer processes exposes the Department to a business continuity risk in the event of employee departures or turnover in key positions.
Supporting Observations
The current administration of offshore revenue and transfer streams involves the processing of a relatively low volume of high dollar value transactions. Processes range from those undertaken on a:
- monthly basis – including receipts and transfers of royalties; receipts of NPI and INPI amounts;
- periodic basis, as required – including receipts and transfers of forfeitures; transfers of corporate income taxes; and
- annual basis – including receipt of annual NPI/INPI reconciliations; calculation, confirmation and transfer of Crown Share Adjustment Payments.
These processes are undertaken in a manual environment involving, for example, e-mailed notifications of amounts owing by interest holders and manual general ledger coding of amounts received. Furthermore, this work is undertaken by a small number of employees of the Petroleum Resources Branch, Energy Policy Branch, and Finance and Procurement Branch.
The audit included detailed testing of a judgemental sample (i.e. selecting transactions with unusual attributes that may not be representative of the population) of transactions for each of the offshore revenue and transfers streams. This testing identified the following:
- Due to manual nature of transaction processing, account coding errors occurred (e.g. an NPI receipt coded to an incorrect general ledger account), however these errors were corrected prior to their having any impact on year-end financial results of the Department; and
- Receipts are processed and transfers are made to the provinces on an accurate and timely basis.
While the sample testing confirmed the existence and effectiveness of current administration processes and internal controls, the audit noted that not all processes and controls have been fully documented.
Current process documentation has been completed in the form of:
- Business process descriptions related to the processing of revenue and transfer transactions for royalties, forfeitures, CIT, NPI and INPI; and
- Business process narratives related to royalties, forfeitures and CIT transactions. These documents were completed as part of NRCan’s Internal Controls for Financial Reporting (ICFR) testing undertaken in 2011/12.
It should be noted that during the course of the audit management was proactive and began updating some of process documents. While these referenced process documents provide guidance for the administration of offshore revenues and transfers, a number of areas require further attention including:
- Process documentation related to the calculation, confirmation and transfer of Crown Share Adjustment Payments (CSAP);
- ICFR process narratives and control descriptions for NPI, INPI and CSAP;
- Process documentation related to NRCan’s review or validation of annual NPI and INPI certified reconciliations provided by interest holders;
- Process documentation related to the monthly reconciliations of offshore revenues and transfer amounts undertaken by the Petroleum Resources Branch, and the periodic financial account reconciliations undertaken by Finance and Procurement Branch; and
- Process documentation related to periodic forecasts developed in support of offshore revenues and transfer amounts.
In the absence of comprehensive process documentation in all areas, NRCan’s reliance on the knowledge of a limited number of employees presents an operational risk to the organization, in the event of turnover in some key positions.
RISK AND IMPACT
The absence of comprehensive documented processes in some areas, combined with NRCan’s reliance on a small number of employees to perform technical functions related to offshore revenues exposes the Department to a business continuity risk in the event of employee departures or turnover in key positions.
RECOMMENDATION 2
It is recommended that the Assistant Deputy Minister, Energy Sector (ES) and the Assistant Deputy Minister, Corporate Management and Services Sector (CMSS), should jointly complete the development of comprehensive process descriptions and internal control documentation to guide the administration of all offshore revenue and transfer streams.
MANAGEMENT RESPONSE, ACTION PLAN AND TIME FRAME
Management agrees that additional process documentation and internal control documents are required in select areas. Work is underway to develop this documentation in two respects:
1. Energy Sector, with input from Corporate Management and Services Sector (CMSS) representatives, will take the lead in finalizing documentation (e.g., process maps) for Crown Share Adjustment Payments, Net Profits Interests (NPI) and Incidental Net Profits Interest (INPI) for inclusion in the Frontier Lands Standard Operating Procedures manual.
Position responsible: Executive Director, Frontier Lands Management Division
Timing: December 31, 2014
2. CMSS, with input from ES representatives, will take the lead in documenting the:
- key internal controls for NPI, INPI and Crown Share Adjustment Payments as part of the exercise undertaken under the Policy on Internal Control;
- financial year-end account reconciliation process; and
- the due dates for submitting forecasts in support of reporting.
Position responsible: Director General, Finance and Procurement Branch
Timing: December 31, 2014
Internal Controls – Validation of NPI/INPI Revenues
Summary Finding
Program management have recognized a need to implement an audit process to ensure the accuracy and completeness of Net Profits Interest and Incidental Net Profits Interest amounts received by the Government of Canada. While an initial audit approach is currently being implemented, FLMD has not yet evaluated the extent to which it could leverage audit work conducted by other oversight bodies to inform its risk-based audit approach.
Supporting Observations
The Hibernia Development Project Net Profits Interest Agreement provides Canada with a 10% net profits interest in the project from each of the project owners. As the project only recently began generating actual profits, project owners became obligated to commence payments in 2009 and are currently making payments on a monthly basis. Through March 31, 2013, Canada had received $1.755 billion in NPI receipts since these required payments commenced.
In addition, the Hibernia Incidental Net Profits Agreement provides Canada with a 10% interest in the profits earned by the original Hibernia project owners for the use of Hibernia facilities to produce hydrocarbons from other licenses. INPI payments to Canada commenced in 2011/12 and are also received on a monthly basis. Through March 31, 2013, Canada had received $539,000 INPI receipts since these required payments commenced.
Under each of these agreements, NRCan has a broad right of audit for any project owner for a period of six years following the NPI/INPI reporting year.
NRCan has implemented processes to receive and account for NPI and INPI monthly notifications and amounts received, however, it has only recently commenced development of a comprehensive validation approach to ensure the completeness of NPI and INPI amounts received.
As part of Frontier Lands Management Division approach to address this area, the following response has been undertaken:
- A review, completed in 2011, of the Hibernia Development Project crude oil measurement, process mapping and identification of key controls to the Hibernia Management and Development Company Ltd.;
- A 2013 review of the NPI and INPI payment processes; and
- The November 2013 hiring a Senior Petroleum Auditor, specifically for the purpose of developing and executing a comprehensive audit plan for NPI and INPI.
Since the hiring of a Senior Petroleum Auditor, an initial risk analysis has been completed by management and an audit plan has been developed to audit the 2013 NPI results for the seven license holders. Results from these initial audits are planned to be reported in June 2014. Program management have also indicated their intention to audit INPI results for the period of 2011-2013, with these audits expected to take place following completion of the 2013 NPI audits.
The audit notes that there are various external auditing activities undertaken by other entities in relation to offshore revenues. These include:
- Audits of annual project owner royalty returns by the Province of Newfoundland and Labrador;
- An annual external audit of the “Statement of Joint Account” (i.e. Hibernia operating costs that are allocated to the project owners);
- An annual Office of the Auditor General audit of the financial statements of the Canada Hibernia Holding Corporation, a Government of Canada entity with an 8.5% ownership of the original Hibernia licenses, and payee of NPI and INPI; and
- An annual Office of the Auditor General audit of the financial statements of the Canada Development Investment Corporation, which include the results of the Canada Hibernia Holding Corporation, a wholly owned subsidiary.
Considering the fact that extensive work is being conducted by various external auditors, the audit found an opportunity for NRCan to evaluate the extent to which it can leverage information from external audit work and their related analytical information, in refining its future risk analysis and audit approach for NPI/INPI. An example of the benefits for such collaboration are found in the Crown Share Adjustment Payments (CSAP) process where NRCan relies on externally audited royalty returns provided by the Province of Nova Scotia as input to the CSAP calculated amount.
RISK AND IMPACT
Until the full implementation of a comprehensive approach to validating NPI/INPI revenues, NRCan is limited in its ability to ensure the accuracy and completeness of this substantial revenue stream.
Furthermore, leveraging the auditing capacity and/or audit results of other oversight bodies (e.g. provincial royalty auditors) could help inform NRCan’s risk assessment and audit approach, including the realization of audit process efficiencies.
RECOMMENDATION 3
It is recommended that the Assistant Deputy Minister, Energy Sector (ES) complete the implementation of a risk-based audit approach to validate Net Profit Interest (NPI) and Incidental Net Profit Interest (INPI) receipts collected by Canada. Ongoing refinement of future audit plans should also include evaluating the extent to which external audit capabilities can be leveraged.
MANAGEMENT RESPONSE, ACTION PLAN AND TIME FRAME
Management agrees.
- ES has completed the planning of the inaugural audits to validate NPI and INPI receipts.
- ES is currently conducting fieldwork for these risk-based audits. The fieldwork phase for NPI and INPI audits will be completed by December 31, 2014 and June 30, 2015 respectively.
- The reports on audit findings will be finalized by August 31, 2015. ES will present an update to the Natural Resources Canada Departmental Audit Committee in September 2015 regarding progress against its NPI/INPI audit plan.
These steps will complete the first part of the recommendation.
The fieldwork plan for each audit, which will occur during 2014, has been designed to leverage existing information from external audit capabilities to the greatest possible extent. For instance, at ES’s request, the Province of Newfoundland and Labrador has offered access to its previous audits of the Hibernia interest holders. In terms of subsequent audits of future/other years of NPI and INPI receipts, those audit plans will further evaluate the extent to which external audit capabilities can be leveraged; this will complete the second part of the recommendation.
Position responsible: Executive Director, Frontier Lands Management Division
Timing: August 31, 2015 (report on inaugural audits) / Ongoing (refinement and leveraging)
Internal Controls – Financial Statement Reporting
Summary Finding
The audit found that Finance and Procurement Branch has year-end financial statement reconciliation procedures in place to identify and correct errors related to the accuracy of the Departmental financial statements.
Supporting Observations
The audit included examination of the extent to which internal controls exist to ensure that offshore revenues and transfers are recognized in NRCan’s financial statements in a complete, accurate and timely manner.
Within NRCan’s annual financial statements, offshore revenues and transfers are presented as revenues and expenses against the following line items:
Revenue
- Rights and Privileges – this line item in the financial statements is composed primarily of offshore royalties received in respect of Newfoundland and Labrador and Nova Scotia.
- Miscellaneous Revenue – this line item is composed primarily of Net Profits Interest and Incidental Net Profits Interest and Forfeiture amounts received, and also includes other items not related to the offshore program.
Expenses
- Statutory Programs - Offshore Royalties (for 2012/13) – this line item includes transfers made to the provinces of Newfoundland and Labrador and Nova Scotia in respect of offshore royalties, corporate income taxes, forfeitures, Crown Share Adjustment Payments and amounts related to the funding of the Canada-Newfoundland and Labrador Offshore Petroleum Board, and the Canada-Nova Scotia Offshore Petroleum Board.
- Economic Opportunities for Natural Resources (for 2011/12 and 2010/11) – this line item consolidates amounts related to Statutory Programs-Offshore Royalties (above) with other NRCan program expenditures.
The audit determined that FPB has year-end financial statement reconciliation procedures in place to identify errors and that corrective actions are taken when discrepancies between the financial statements and the supporting general ledger account balances exist.
The audit also confirmed that amounts reported by the Department for Public Accounts, related to Offshore Revenues, were accurate.
Internal Controls – Opportunities for Collaboration
Summary Finding
In developing its financial forecasts for offshore revenues and transfers, NRCan does not currently actively collaborate with the provinces. While there is no guarantee that collaboration with the provinces will result in more accurate forecasts, the provinces have key information on offshore projects (e.g. Newfoundland and Labrador project royalty returns) not readily available to NRCan. This information could serve to better inform the assumptions used by NRCan in developing offshore revenue and transfer forecasts.
Supporting Observations
Forecasted results for offshore revenue and transfer streams represent a key management information need to Departmental accountability reporting requirements (e.g. Report on Plans and Priorities, Future Oriented Financial Statements).
Forecasted versus actual results for offshore revenues and transfers have varied significantly in the recent past as summarized below:
| REVENUES | 2012/13 Forecast (MM) | 2012/13 Actual (MM) | Actual as a % of Forecast | |
| Rights and privileges | $1,126 | $543 | 48% | Includes Royalty receipts |
| Miscellaneous revenue | $381 | $471 | 124% | Includes NPI, INPI and Forfeitures |
| EXPENSES | ||||
| Statuatory Programs - Atlantic Offshore | $1,135 | $592 | 52% | Includes Royalty, CIT, Forfeiture and CSAP transfers |
(Source: NRCan Statement of Operations and Departmental Net Financial Position for the year ended March 31, 2013)
Forecasts for these revenue and transfer streams are subject to a complex set of shifting variables and require assumptions and estimations to be determined for a variety of factors such as oil prices, production levels and production costs. With the exception of NPI/INPI and CSAP, any forecast to actual variation in amounts received (e.g. royalties) by Canada will be offset by the same variance in amounts transferred to Nova Scotia and Newfoundland and Labrador by Canada.
Forecasts are currently developed within the Energy and Economic Analysis Division for the following offshore streams:
- Royalties (receipts and transfers),
- NPI (receipts), and
- Crown Share Adjustment Payments.
Inputs to this process include external oil price forecasts, project development plans and amendments from the Canada-provincial offshore petroleum boards, project royalty rates and annual NPI forecasts provided by Hibernia project owners.
INPI and forfeiture amounts are not currently forecasted due to materiality considerations, and CIT amounts are estimated based on a historical 4-year average.
Up until 2007, NRCan relied on the provinces for royalty and CIT estimates. According to program management, NRCan discontinued the practice for various reasons, including that the fact that NRCan’s previous reliance on the provinces for such forecasts reduced their ability to explain variances from forecasted results.
While there is no guarantee that collaboration with the provinces will result in more accurate forecasts, the provinces have key information on offshore projects (e.g. Newfoundland and Labrador project royalty returns) not readily available to NRCan. This information could serve to better inform the assumptions used by NRCan in developing offshore revenue and transfer forecasts.
During the course of the audit, it was noted that program representatives of FLMD have taken the initial step of engaging provincial representatives to explore the referenced collaboration opportunity.
RISK AND IMPACT
A lack of information sharing with the provinces in the development of NRCan offshore revenue and transfer forecasts increases the risk of NRCan using incorrect or inaccurate forecasting information (e.g. project royalty rates).
RECOMMENDATION 4
The Assistant Deputy Minister, Energy Sector (ES) should formally engage representatives from the provinces of Newfoundland & Labrador and Nova Scotia and define opportunities to further share information related to provincial royalty and corporate income tax forecast information, to better inform their respective forecasts.
MANAGEMENT RESPONSE, ACTION PLAN AND TIME FRAME
Management agrees.
ES is working to improve the accuracy of forecasts. In March 2014, Natural Resources Canada sent letters to the province of Newfoundland and Labrador and to the province of Nova Scotia requesting information sharing and collaboration on the verification of offshore petroleum Royalty and Corporate Income Tax (CIT) forecasts. Both provinces have agreed to share information and, in particular, collaborate to verify Natural Resources Canada’s forecasts prior to finalization.
To complete the response to the recommendation, ES will share a document with both provinces that defines frequent and consistent opportunities throughout each fiscal year to share information and, on a go forward basis, provide opportunities to verify these forecasts. This document will also outline ES’s forecasting methodology for provincial consideration.
Position responsible: Executive Director, Frontier Lands Management Division
Timing: June 30, 2014
APPENDIX A – OVERVIEW OF KEY ORGANIZATIONS AND ROLES IN ADMINISTRATION OF OFFSHORE REVENUES AND TRANSFERS
Provided below is a summary of key organizations and respective roles related to the administration of offshore revenues and transfers within NRCan, as defined by both the Energy Sector and the Financial Procurement Branch.
| Petroleum Resources Branch | |
|---|---|
| Frontier Lands Management Division |
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| Energy Policy Branch | |
| Energy and Economic Analysis Division |
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| Finance and Procurement Branch | |
| Financial Services - Revenue and Accounts Receivable Unit |
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| Financial Services – Grants & Contributions Unit |
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| Sector Financial Advisor group Corporate Reporting Corporate Resource Management |
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| Financial Management and Internal Controls |
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APPENDIX B – AUDIT CRITERIA
The audit criteria were derived from widely recognized control models (e.g. Management Accountability Framework, CICA Criteria of Control - CoCo) and relevant policies, acts and legislation. Actual performance was assessed against the audit criteria resulting in either a positive finding or the identification of an area of improvement.
The overall purpose of the audit is to provide reasonable assurance that NRCan has a management control framework in place to effectively administer and manage offshore revenues and transfers.
The following audit criteria were used to conduct the audit:
| Audit Sub-Objective | Audit Criteria |
|---|---|
| There is an effective governance structure in place for managing offshore revenues and transfers. | Roles, responsibilities and accountabilities are clearly defined and documented. |
| Roles, responsibilities and accountabilities are well understood. | |
| Management has established comprehensive guidance to ensure appropriate administration and reporting of NRCan offshore revenues and transfers. | |
| Complete, accurate and timely information related to offshore revenues and transfers is provided to NRCan management for decision-making. | |
| Effective internal controls* exist to ensure accurate, complete and timely reporting of offshore revenue and transfers. *Note: Internal controls include controls related to the relevant activities of both the Program and Finance functions in relation to offshore revenues and transfers. |
NRCan internal controls appropriately reflect the risks associated with ensuring the accuracy and completeness of its offshore revenue and transfer streams. |
| NRCan offshore revenue and transfer processes and internal controls have been appropriately documented and communicated, and are being followed. | |
| NRCan offshore revenues and transfers are administered in compliance with applicable Treasury Board and NRCan policies. | |
| Effective internal controls exist to ensure that offshore revenues and transfers are recognized in NRCan’s financial statements in a complete accurate and timely manner. |
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