10 November 2004 External T.I. 2004-0096611E5 - photovoltaic system

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: tax treatment of photovoltaic system used in a business

Position: Outlined requirements of Class 43.1 and Reg. 1219 (CRCE)

Reasons: as per legislation

. 2004-009661
XXXXXXXXXX Catherine Bowen
(613) 957-8284
November 10, 2004

Dear XXXXXXXXXX:

Re: Tax Incentives for Investments in Renewable Energy Projects

This is in response to your letter dated September 29, 2004 wherein you requested our comments on the income tax treatment of a photovoltaic system to be used in your customers' businesses, such as on the roof of a residence/barn of a cattle operation or to supply a car wash with electrical power. Tom Jewett of Natural Resources Canada provided us with a copy of his e-mails sent to you on September 30 and October 17, 2004.

Our Comments

Written confirmation of the income tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request as described in Information Circular 70-6R5 dated May 17, 2002 issued by the Canada Revenue Agency. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. Although we cannot provide any comments with respect to the specific asset referred to in your letter, the following general comments may be of assistance.

Class 43.1

To qualify as a Class 43.1 property, fixed location photovoltaic equipment must be used by the taxpayer, or by a lessee of the taxpayer, primarily for the purpose of generating electrical energy from solar energy and

? have a peak capacity of not less than 3 kilowatts of electrical output, and

? consist of solar cells, modules or array and related equipment, including:

a. control, conditioning and battery storage equipment,
b. support structures, and
c. transmission equipment up to the interface with either the distribution system or the local utility.

Assets that may be part of a photovoltaic system but are not eligible to be included in Class 43.1 are electrical distribution equipment and facilities, other back-up generating equipment (such as a diesel engine, main switch or power bar), vehicles, telephone equipment, access roads, sidewalks and other assets normally included in Class 10 or 17. Also, operating costs and costs of spare parts inventory are not eligible for inclusion in Class 43.1.

We understand that Mr. Jewett has sent you the forms that need to be completed in order to request a technical opinion from Natural Resources Canada as to whether the photovoltaic system referred to in your letter is one that is described in Class 43.1.

In addition, for property to be eligible for inclusion in Class 43.1, it must:

? be situated in Canada;
? be acquired by a taxpayer for use by the taxpayer, or to be leased by the taxpayer to a lessee for use by the lessee, for the purpose of earning income from a business carried on in Canada or from property situated in Canada; and
? not have been used for any purpose before the taxpayer acquired the property (other than for certain used equipment that is depreciable property that was eligible for inclusion in Class 34 or 43.1 of the vendor, remains at the same location as used by the vendor and has been acquired by the taxpayer within five years from the time it became available for use to the vendor).

A property will only be considered not to have been used for any purpose where it is new at the time that it is acquired. New equipment that is demonstrated for or tested by a prospective purchaser of that particular piece of equipment will not normally be considered to have been used for a purpose. However, a property that is used regularly by the vendor for demonstration purposes is considered to have been used by the vendor. Consequently, the testing and commissioning of an otherwise new system prior to the purchaser taking possession will not normally result in a finding that the property has been used prior to its acquisition.

CCA for Class 43.1

Class 43.1 provides for a capital cost allowance ("CCA") rate of 30 per cent calculated on a declining balance basis. Any property acquired in the year is subject to the 50% rule found in subsection 1100(2) of the Income Tax Regulations (the "Regulations"). This means that the rate of CCA in the year the Class 43.1 property is acquired or becomes available for use is 15% and then 30% in the subsequent years. In addition, by virtue of the "available for use rules" found in subsections 13(26) to (31) of the Income Tax Act (the "Act"), CCA for any Class 43.1 property that has been acquired and which is not considered available for use at the end of a taxation year may be restricted until such time as the property is available for use. Note: where a depreciable property is used for both business and personal use, CCA can only be claimed on the portion or percentage of the capital cost that is used for business purposes.

Where Class 43.1 property meets the definition of "specified energy property" in subsection 1100(25) of the Regulations, the amount of CCA that may be claimed on that property is generally limited to the income earned from such property (as per subsection 1100(24) of the Regulations). However, where Class 43.1 property is acquired to be used by the owner primarily for the purpose of gaining or producing income from a business carried on in Canada (other than the business of selling energy produced by the property) or from another property situated in Canada (e.g., rental property), this restriction does not apply. In other words, as long as the purchasers of photovoltaic systems that qualify for inclusion in Class 43.1 are using them in their own businesses, they will not normally be affected by these rules restricting the amount of CCA that can be claimed.

Canadian renewable and conservation expense

Certain expenses incurred in the pre-production development phase of renewable energy and energy conversation projects, where it is reasonable to expect that at least 50% of the capital cost of the depreciable property to be used in the project would qualify for inclusion in class 43.1, will meet the definition of "Canadian renewable and conservation expense" ("CRCE") in section 1219(1) of the Regulations if, among other things, they are payable to

? a person or partnership with whom the taxpayer is dealing at arm's length, and

? a Canadian resident or a Canadian partnership (i.e., a partnership all of the members of which are Canadian residents). An exception to this rule is where a taxpayer purchases a test wind turbine for a qualifying project.

Examples of the types of expenses that are and are not eligible for CRCE are listed on page 5 of the Tax Incentives for Business Investments in Energy Conservation and Renewable Energy guide ("Tax Incentives Guide") referred to in your letter. Expenses that are eligible for CRCE generally do not include amounts that would otherwise be included in the capital cost of depreciable property. For the photovoltaic system you have described, it is likely that if there are any expenses that do qualify as CRCE, they would be for an insignificant amount. Where expenses do qualify as CRCE, they are added to the taxpayer's Canadian exploration expense pool (as per paragraph (g.1) of the definition of "Canadian exploration expense" in subsection 66.1(6) of the Act). They can be deducted entirely in the year they are incurred or carried forward indefinitely and deducted in later years.

Flow-through shares

As indicated on page 2 of the Tax Incentives Guide, CRCE can be renounced (or passed along) to shareholders of a corporation through a flow-through share agreement. In general, such agreements allow a "principal business corporation" to raise funds for financing its proposed energy conservation or renewable energy project by issuing flow-through shares. However, amounts may only be renounced to a particular investor in respect of CRCE incurred by the corporation on or after the date the agreement in writing relating to the acquisition of the flow-through share was made. The shareholders can deduct the CRCE renounced to them against their own income. A "principal business corporation" (as defined in subsection 66(15) of the Act) includes, among other things, a corporation the principal business of which is any of, or a combination of

? the generation of energy using property described in Class 43.1, and

? the development of projects for which it is reasonable to expect that at least 50% of the capital cost of the depreciable property to be used in each project would be the capital cost of property described in Class 43.1.

The examples of potential purchasers provided in your letter do not appear to meet the definition of a "principal business corporation", and therefore, could not issue flow-through shares in respect of any CRCE incurred by them. However, as stated above, the purchasers can deduct any CRCE they incur from the income earned from their own businesses.

Our comments are provided in accordance with the practice outlined in paragraph 22 of IC-70-6R5. We trust our comments are of assistance.

Yours truly,

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Planning Branch

c.c. Mr. Tom Jewett

CANMET Energy Technology Centre
Bell's Corners Complex, Building 3, Room 213A
1 Haanel Drive
Nepean ON K1A 1M1