20 February 2007 External T.I. 2006-0216881E5 - Photovoltaic equipment

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: The tax consequences of operating a photovoltaic program.

Position: Provided general information on the CCA rules for Class 43.1 and 43.2 and on the types of expenses that are eligible for CRCE.

Reasons: It must meet the technical requirements of the Act and the Regulations

XXXXXXXXXX 							2006-021688
								Fiona Harrison
February 20, 2007

Dear XXXXXXXXXX:

Re: Proposed Photovoltaic XXXXXXXXXX Energy Program

This is in reply to your electronic request of December 4, 2006, wherein you requested our comments in respect of the tax consequences of a proposed photovoltaic XXXXXXXXXX energy program.

It is our understanding that the Ontario Power Authority ("OPA") and the Ontario Energy Board have developed a Renewable Energy Standard Offer Program for the Province of Ontario (the "Program"), designed to encourage and promote greater use of renewable energy sources, including solar, from smaller generating projects that would be connected to an electricity distribution system in Ontario. Under the Program, an applicant will enter into a contract with the OPA, pursuant to which the applicant will deliver electricity to a local electricity distribution system in Ontario for a 20-year period. To qualify under the Program, applicants must ensure that the project meets certain requirements, must be willing to make necessary investments in their facilities and must bear the costs of connection to the local distribution system and metering, as well as certain ongoing costs of operation and maintenance.

Pursuant to a telephone conversation of February 1, 2007, (XXXXXXXXXX/Harrison), you advised that you propose to apply under the Program in respect of a photovoltaic project with a cost of approximately $XXXXXXXXXX. You note that the photovoltaic equipment will be attached to the roof of an existing building and that a lease will be entered into with the owner of the building to enable this equipment to be attached to the roof. You are considering using either a limited partnership or a corporation as the vehicle to finance and carry out the project and your specific questions relate to the deductibility of Canadian renewable and conservation expenses ("CRCE") incurred in the project and the tax consequences to the unitholders or shareholders.

Our Comments

As previously indicated, 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.

Type of Assets

To qualify for inclusion in subparagraph (d)(vi) of Class 43.1 of Schedule II to the Income Tax Regulations (the "Regulations"), 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

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

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

a. control, conditioning and battery storage equipment (designed to store electrical energy),

b. support structures for the solar array, 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 buildings, electrical distribution equipment and facilities, other back-up electrical generating equipment, vehicles, telephone equipment, access roads, sidewalks and other assets normally included in Class 10 or 17. However, electrical generating equipment described in subparagraph (a.1)(i) of Class 17 is eligible for inclusion in Class 43.1.

As noted above, a building does not qualify for inclusion in Class 43.1. However, where a photovoltaic array is attached or held (e.g., by bolts or by weights) to the roof of an existing building such that

i) it would be considered to have a separate existence from that of the building as movable capital property, and

ii) it does not form an integral and component part of the building

it is our opinion that it would not be considered part of the building and the photovoltaic system would qualify for inclusion in Class 43.1 provided the other criteria are met. Similarly, where a tenant that is leasing a building incurs the cost of installing such a photovoltaic system and it remains the property of the tenant that can be removed by the tenant, it is our opinion that such a system would also qualify for inclusion in Class 43.1 provided the other criteria are met.

Use of Property

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

i) be situated in Canada,

ii) 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

iii) 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).

Pursuant to subsection 1102(21) of the Regulations, the capital cost of any used equipment that qualifies for inclusion in Class 43.1 as described in (iii) above cannot exceed the original capital cost of the property to the person from whom the property was acquired. Any excess should be included in the class in which the particular property would have been included if it were not eligible for inclusion in Class 43.1.

A property will not be considered 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. 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. However, a property that is used regularly by the vendor for demonstration purposes is considered to have been used by the vendor.

Property that is described in paragraph (d) of Class 43.1 that is acquired after February 22, 2005 and before 2012 may, provided that the property has never been included in another class by any taxpayer before the taxpayer acquired it, be included in Class 43.2.

CCA rate

Property included in Class 43.2 is eligible for a capital cost allowance ("CCA") rate of 50 per cent, while property included in Class 43.1 is eligible for a CCA rate of 30 per cent. However, by virtue of the "available for use rules" found in subsections 13(26) to (31) of the Income Tax Act (the "Act'), CCA for a Class 43.1 or 43.2 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. A property that becomes available for use in the year is subject to the 50% rule found in subsection 1100(2) of the Regulations. Where a depreciable property is used for both personal and business use, CCA can only be claimed on the portion or percentage of the capital cost that is used for business purposes.

Restriction on CCA claim

The amount of CCA that may be claimed on a Class 43.1 or 43.2 property (as discussed above) is limited to the income earned from such property (as per subsection 1100(24) of the Regulations) unless certain conditions are met. This limitation on CCA that may be claimed will not apply where any of the following conditions are met:

i) the owner of the Class 43.1 or 43.2 property is a principal business corporation (as described below) or a partnership each member of which is a principal business corporation,

ii) the Class 43.1 or 43.2 property is acquired to be used by the owner primarily (i.e., more than 50%) 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 includes the situation where the Class 43.1 or 43.2 property is used primarily to generate electricity for the owner's own existing business (e.g., farming, car wash, etc.), or

iii) the Class 43.1 or 43.2 property is leased by its owner in the ordinary course of carrying on business in Canada and certain conditions relating to the business carried on by the lessor and the lessee are met.

For these purposes, a principal business corporation ("PBC") means a corporation whose principal business throughout the year was

i) manufacturing or processing,

ii) mining, or

iii) the sale, distribution, or production of electricity, natural gas, oil, heat, or any other form of energy or potential energy.

If none of the conditions listed above is met (e.g., where a taxpayer that is not a PBC acquires a Class 43.1 or 43.2 property primarily to generate electrical energy for sale), the property will be considered "specified energy property" for purposes of subsection 1100(25) of the Regulations and CCA on that property can not be deducted to the extent that doing so would create or increase a loss from all such property owned by the taxpayer.

Canadian renewable and conservation expense

Certain expenses incurred in the pre-production development phase of renewable energy and energy conservation projects, 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 qualify for inclusion in Class 43.1 or 43.2, may qualify as "Canadian renewable and conservation expense" ("CRCE") as defined in subsection 1219(1) of the Regulations if, among other things, they are not

a) payable to a person or partnership with whom the taxpayer is not dealing at arm's length, or

b) specifically excluded from CRCE under subsection 1219(2) of the Regulations (see below).

Examples of the types of expenses that are eligible for CRCE include:

i) the cost of pre-feasibility and feasibility studies of suitable sites;

ii) costs related to determining the extent, location and quality of energy resources;

iii) negotiation and site approval costs;

iv) the cost of constructing a temporary access road to the project site; and

v) site preparation costs that are not directly related to the installation of equipment.

Examples of the types of expenses that are not eligible for CRCE, in the case of a photovoltaic project, include:

a) amounts that would otherwise be included in the capital cost of depreciable property, including all costs directly associated with the acquisition and installation of the property, except those described in i) to v) above as qualifying as CRCE;

b) financing and interest charges;

c) administration and management expenses;

d) amounts paid to a non-resident person or a partnership of which one or more of the members are not a resident of Canada; and

e) costs related to the acquisition or use of land, as well as the grading and levelling of land, except those described in i) to v) above as qualifying as CRCE.

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, where expenses do qualify as CRCE, they are added to a taxpayer's Canadian exploration expense (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. It is our understanding that a photovoltaic project would not generally involve substantial CRCE amounts.

Flow-through shares

CRCE can be renounced (or passed along) to shareholders of a "principal business 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

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

b) 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.

Partnership

Pursuant to paragraph (h) of the definition of Canadian exploration expense ("CEE") in subsection 66.1(6), CRCE incurred by a partnership will be allocated to those persons who are partners of the partnership at the end of that fiscal period of the partnership. Subject to section 66.8, which is described below, CEE allocated to a partner in a fiscal period of the partnership

• is deemed for the purpose of the definition of "cumulative Canadian exploration expense" in subsection 66.1(6) ("cumulative CEE pool") to have been incurred by the partner at the end of the partnership's fiscal period pursuant to subsection 66(18) of the Act, and
• is added to the partner's cumulative CEE pool by virtue of element A of the definition of "cumulative Canadian exploration expense" in the partner's taxation year that includes the fiscal period end of the partnership.

"At-risk" Rules

Where a partner of a partnership is considered to be a limited partner (as defined in subsection 96(2.4) of the Act), subsection 66.8(1) provides that the amount of CEE that may be allocated to the partner and added to the partner's cumulative CEE pool cannot exceed the amount by which the partner's "at-risk amount" (as defined in subsection 96(2.2) of the Act) at the end of the fiscal period of the partnership exceeds the partner's share of any investment tax credits or farm losses of the partnership for that fiscal period.

Where a limited partner's share of CEE allocated from a partnership is greater than the partner's at-risk amount and is, therefore, not deductible in the year, the excess is considered to be CEE of the partner in the immediately following fiscal period of the partnership and may, again subject to subsection 66.8(1) of the Act, be allocated to the partner and added to the partner's cumulative CEE pool and be deducted in that year.

It should be noted that where a partnership is capitalized with limited recourse debt the tax-shelter rules in section 237.1 and the limited-recourse rules in section 143.2 of the Act may be applicable.

Adjustments to the ACB of the partnership units

Immediately after the fiscal year-end of the partnership in which the CEE is allocated to a partner, the ACB of the partner's interest in the partnership will be reduced under clause 53(2)(c)(ii)(C) of the Act by the amount of CEE allocated by the partnership to the partner. However, if the amount allocated to the partner has been reduced as a result of the application of subsection 66.8(1) as described above, only the reduced amount will be subtracted from the ACB of the partnership units. In addition, the ACB of the partnership interest will also generally be reduced by virtue of subparagraph 53(2)(c)(i) of the Act by the partner's share of any partnership loss for that fiscal period that is allocated to the partner. Conversely, the ACB of the partnership interest will be increased by virtue of subparagraph 53(1)(e)(i) of the Act by the partner's share of any partnership income for that fiscal period that is allocated to the partner.

We trust our comments are of assistance.

Yours truly,

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate