19 May 2006 External T.I. 2006-0168291E5 - CRCE - small hydro installation

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: Whether certain expenditures relating to a small hydro installation would constitute CRCE.

Position: General comments provided.

Reasons: In accordance with the practice outlined in paragraph 22 of IC 70-6R5.

							2006-016829
XXXXXXXXXX 						A.A. Cameron
(613) 347-1361
May 19, 2006

Dear XXXXXXXXXX:

Re: Small-Scale Hydroelectric Installation

This is in reply to your electronic mail message of January 24, 2006 requesting our opinion as to whether certain costs relating to a small-scale hydroelectric installation to be developed by your company will be eligible for inclusion in Canadian renewable and conservation expense ("CRCE") as defined under subsection 1219(1) of the Income Tax Regulations (the "Regulations"). In particular, you have asked whether the cost of drilling XXXXXXXXXX (creating an opening approximately XXXXXXXXXX inches in diameter) would qualify as CRCE under paragraph 1219(1)(f) of the Regulations.

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. A fee is charged for this service. Although, we are unable to provide any comments with respect to your particular fact situation otherwise than in the form of an advance income tax ruling, the following general comments may be of assistance.

Canadian Renewable and Conservation Expense / Class 43.1

The determination of whether a particular expense incurred by a taxpayer will qualify for inclusion in CRCE must be made based upon a review of all of the facts relevant to a particular situation. However, in general terms, expenses incurred by a taxpayer in respect of the development of a project for which it is reasonable to expect that at least 50% of the capital cost of the depreciable property to be used in the project would be the capital cost of any property that is described in Class 43.1 of Schedule II to the Regulations ("Class 43.1") may constitute CRCE to the taxpayer provided they are payable to a person or partnership with whom the taxpayer is dealing at arm's length and to the extent they are not specifically excluded from CRCE under subsection 1219(2) of the Regulations, e.g., certain expenses in respect of overhead and management, financing and interest, or the acquisition, or use of, land, as well as, generally, amounts payable to a non-resident person or to a partnership if all of the members thereof are not resident in Canada. Furthermore, the capital cost of depreciable property, including that described in Class 43.1, or an eligible capital expenditure will not generally qualify as CRCE.

Pursuant to paragraph 1219(1)(f) of the Regulations, eligible CRCE costs include an amount incurred by a taxpayer "for the drilling or completion of a well for the project". As the word "well" is not defined for these purposes, it should be given its ordinary meaning. In our opinion, an opening of the size suggested which is drilled XXXXXXXXXX would not be considered a "well" within the ordinary meaning of that term.

In addition, while the classification for income tax purposes of costs incurred in drilling an opening such as that referred to above would be a question to be determined from all the facts relevant to a particular situation, it is our view that such costs would likely be precluded from CRCE pursuant to subsection 1219(2) of the Regulations. For example, as a cost relating to "the use of...land" under subparagraph 1219(2)(b)(i). In addition, if such drilling costs formed part of the capital cost of depreciable property they would be excluded from CRCE under subparagraph 1219(2)(b)(iv).

With regard to depreciable property, we would note that a hydro-electric installation situated in Canada that is acquired after December 10, 2001 and that has a rated capacity not exceeding 50 MW at the hydro-electric installation site may qualify for inclusion in Class 43.1 under clause (d)(ii)(A) of that class. Under clause (d)(ii)(B) of Class 43.1, the hydro-electric installation of a producer of hydro-electric energy includes the electrical generating equipment and plant, including structures, of that producer [but does not include distribution equipment and property otherwise included in Class 10 or 17 (other than certain electrical generating equipment described in subparagraph (a.1)(i) thereof) of Schedule II to the Regulations]. Where costs incurred in drilling an opening such as that referred to above cannot be considered to be in respect of an improvement to land and relate to the creation of a structure forming part of the relevant electrical generation plant they may form part of the capital cost of such property included in Class 43.1.

Flow-through shares

Pursuant to paragraph (g.1) of the definition of "Canadian exploration expense" ("CEE") in subsection 66.1(6) of the Act, expenses incurred by a taxpayer that qualify as CRCE are included in the taxpayer's CEE. A taxpayer that qualifies as a "principal-business corporation" ["PBC", as defined in subsection 66(15) of the Act] may be able to renounce amounts, in respect of the CEE incurred by it, to an investor that has acquired a "flow-through share" [also as defined in subsection 66(15) of the Act] in its capital stock. However, amounts may only be renounced to a particular investor in respect of CEE incurred by the taxpayer on or after the date the agreement in writing relating to the acquisition of the flow-through share was made. With regard to the definition of PBC, it provides, in part, that such term "means a corporation the principal business of which is any of, or a combination of," certain specified activities including:

(h) the generation of energy using property described in Class 43.1 of Schedule II to the Income Tax Regulations, and

(i) 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 of Schedule II to the Income Tax Regulations.

Class 43.2

It should be noted that the February 23, 2005 federal budget announced that renewable energy generation equipment, including small-scale hydroelectric facilities, that would otherwise be included in Class 43.1 and that is acquired on or after the date of the budget and before 2012 will qualify for proposed new Class 43.2, having a 50% capital cost allowance rate. Should this change be promulgated, any reference to "Class 43.1" in this letter should be read as a reference to "Class 43.1 or Class 43.2". The Budget Plan 2006 document tabled in the House of Commons on May 2, 2006 as part of the federal budget confirmed that it was the government's intention to enact regulations to implement this change.

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
Legislative Policy and Regulatory Affairs Branch