BC Rail Investment Partnership

Restructuring the British Columbia Railway Company

Early in 2003, the Province of British Columbia (Province) undertook to restructure the British Columbia Railway Company (BCRC). This restructuring initiative was aimed at seeking investment by third party operators in the freight railway.

The Freight Railway

The objectives for seeking investment in the freight railway were developed in consultation with communities along the railway line as well as British Columbia's shippers. The objectives were:

• Sustainability — proponents had to promote a robust and well-maintained transportation infrastructure, which supports the long-term economic development and diversification of communities throughout British Columbia;
• Competitiveness — proponents had to recognize industrial customers' desire for competitive freight rail services and rates while ensuring integrated North American access to preferred markets and carriers for interline rail shipments;
• Growth Opportunities — proponents had to accommodate access to the railway line for third party passenger rail services on reasonable economic terms and identify any new opportunities for freight rail services; and
• Community Specific Issues — proponents had to demonstrate how they would benefit key groups, such as employees, communities, and First Nations and ensure continuation of the rail shuttle service between D'Arcy and Lillooet.

On November 25, 2003, the province announced that the Canadian National Railway Company (CN) was the successful proponent to invest in the railway and assume operations of BCRC's freight railway as they best responded to the objectives identified by the Province, communities and shippers.

CN will pay the Province $1.005 billion for the opportunity to operate the freight railway. CN will acquire the outstanding shares of BC Rail Ltd. and all of the interests in the BCR Partnership. BCRC, which will remain a Crown corporation, will retain ownership of the right-of-way, railbed and track. The railway right-of-way and infrastructure will be leased on a long-term basis to CN. The term of the lease is 60 years with an initial renewal of term of 30 years.

Charles River Associates, in their December 17, 2003, report entitled "Fairness Evaluation of the Restructuring of the BC Rail Freight Division," confirmed that the Province and its advisors designed and managed the partnership process in a fair and impartial manner and ensured the best proposals were put forward for consideration. The report concluded that the Province will receive fair value from CN for the opportunity to operate the freight railway.

It is anticipated that the investment partnership will be finalized prior to the end of the 2003/04 fiscal year. However, the investment partnership is currently under review by the federal government's Competition Bureau and will not conclude until that review has been completed.

Investing in Jobs and Opportunities

As a result of the partnership between BCRC and CN, the Province will be in a position to directly invest in northern communities and provide opportunities for First Nations along the railway line to undertake economic development initiatives.

$135 Million for Northern Communities

Proceeds from the investment partnership will be used to establish a $135 million Northern Development Initiative to support investments related to forestry, pine beetle recovery, transportation, tourism, mining, Olympic opportunities, small business, economic development, energy and sustainable communities. Headquartered in Prince George, the Initiative will be established in legislation and structured as follows:

• $25 million for an operating endowment account, with the interest used to support the operations of the Northern Development Initiative;
• Four $15 million regional development accounts – Prince George, Peace, Northwest and Cariboo-Chilcotin/Lillooet regions and
• $50 million for a cross-regional account to support investments, economic development and job creation in one or more regions.

A board, also established in legislation, will administer the Northern Development Initiative. The board, with a majority appointed from the regions, will be assisted by a regional advisory committee for each of the four regions to provide input on spending priorities. The regional advisory committees will include locally elected community officials as well as members of the Legislative Assembly.

$15 Million First Nations Benefits Trust

A $15 million BC Rail First Nations Benefits Trust will be established by legislation to support economic development, educational advancement and cultural renewal for the 25 First Nations along the freight railway corridor. This may include funding to: build capacity and provide seed-capital for aboriginal enterprises and joint partnerships; protect and promote First Nations' languages; support initiatives for aboriginal youth apprenticeship training; and other initiatives. Final objectives for Trust funding, structure and governance will be based on consultation with the 25 First Nations along the railway corridor.

Other Initiatives

Other transportation related infrastructure projects will also be supported from proceeds related to the investment partnership, examples include BCTFA capital program initiatives such as the $4 million for expansion to the Prince George Airport, and $17.2 million for container terminal development at the Port of Prince Rupert. A $13 million contribution will be made to Legacies Now to support the development of sport, recreation, arts, music and volunteer initiatives. In addition, $6 million will be invested in Asia Pacific Market Outreach initiatives and fuel cell research. Up to an additional $13 million will be invested in projects/initiatives to be identified once the investment partnership has been concluded.

Accounting Approach

BCRC is a commercial Crown corporation able to fund itself from sources outside of government. BCRC's financial statements are consolidated into the province's Summary Financial Statements on the modified equity basis of consolidation, meaning the original investment by the Province in BCRC is recorded at cost. The Province's investment is adjusted annually to include earnings and losses and other net equity changes of BCRC.

BCRC prepares its financial statements in accordance with Generally Accepted Accounting Principles for commercial entities. Under these principles, assets and liabilities of the corporation's subsidiaries are shown on its balance sheet as assets and liabilities of BCRC.

The gross cash proceeds of the transaction to BCRC will be $1 billion. In addition, debt with a present value of $5 million will remain outstanding and be payable by CN to BCRC in 90 years, resulting in a gross transaction value of $1.005 billion. The investment partnership will mean CN will prepay rent for the long-term lease of the railway right-of-way. The investment partnership is expected to conclude by March 31, 2004.

The investment partnership with CN is estimated to result in a net gain of $182 million which will be recognized in the fiscal year in which it is concluded. Table One shows how that gain has been determined and how the positive impact on BC Rail net income is offset by an equal amount of expenditures as the gain is reinvested in northern and First Nations' communities. As the investment partnership has not yet concluded and is subject to review by the Competition Bureau, the estimates contained in the table are subject to finalization.

Table Two outlines the disposition of the $1 billion cash proceeds.

The monies payable to the Northern Development Initiative and the BC Rail First Nations Trust are subject to the investment partnership with CN concluding and net proceeds being received. Legislation will be introduced to create both the Northern

Development Initiative and the First Nations Benefits Trust, to authorize applicable expenditures and the transfer of proceeds from BCRC to the Province. The payments to the Northern Development Initiative and the First Nations Benefits Trust will represent an expense in the year they are made. In addition to funding these initiatives, $200 million will be provided to the British Columbia Transportation Financing Authority (BCTFA) for the multi-year capital program. This BCTFA transfer represents the redistribution of cash from one part of the government reporting entity to another, and has no impact on the government's bottom line.

BCRC and the Province have provided commercial indemnities to CN with respect to the purchase of the subsidiary and partnership, including indemnities related to tax attributes. BCRC and the Province, based on independent legal advice, believe there is a very low risk these indemnities will be called upon.

The Province will report indemnities that have an amount identified with them as guaranteed debt in the notes to the Summary Financial Statements. The amount of the guarantee will also be included as part of total taxpayer-supported debt reported in the Budget, Summary of Provincial Debt and Quarterly Reports. The indemnities are a non-cash debt item and do not incur interest. Those indemnities without a specific amount identified will be reported as contingent liabilities in the notes to the Summary Financial Statements.

Following completion of the investment partnership, BCRC will remain a Provincial Crown corporation. Its primary function will be to own the railway right-of-way, railbed and track and administer the lease agreement with CN. In addition, BCRC will continue to operate several non-railway related subsidiaries, such as Vancouver Wharves.

Impact of a Delay in Concluding the Investment Partnership

Legislation establishing the Northern Development Initiative and the First Nations Benefits Trust will be introduced before March 31, 2004 and will anticipate the possibility that the Competition Bureau review will extend into fiscal year 2004/05. The legislation therefore ties the provincial commitments to reinvest to the completion of the investment partnership. This means that the $182 million in revenues from the proceeds and associated expenditures will occur within the same fiscal year. This will result in no impact on the Province's bottom line. However, if the investment partnership does not conclude until fiscal 2004/05, the planned debt reduction would be delayed. While provincial debt as of March 31, 2004, would be higher than currently forecast, debt would return to forecast levels upon completion of the partnership transaction.