9 March 2007 External T.I. 2007-0225661E5 - Renewable Energy Property

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: Request for description of property encompassed by paragraph (d) of Class 43.1 and Class 43.2.

Position: General comments provided.

Reasons: As requested.

								2007-022566
XXXXXXXXXX 							A.A. Cameron
(613) 347-1361
March 9, 2007

Dear XXXXXXXXXX:

Re: Capital Cost Allowance - Class 43.1 and 43.2

We are writing further to your electronic mail message of February 26, 2007 concerning property qualifying for inclusion in Classes 43.1 and 43.2 of Schedule II to the Income Tax Regulations (the "Regulations"). In particular, you have asked for a description of the types of property described in paragraph (d) of Class 43.1 that may be of interest to farmers, greenhouse operators or other rural businesses. You have also indicated that in certain circumstances the property may be acquired to participate in the "Net Metering" program of the Ontario government or the electricity generated from such property may be sold to the provincial power authority under a standard offer contract.

We understand that Ontario's net metering program is available to any Ontario electrical customer who generates electricity primarily for the participant's own use from a renewable source, for example wind or photovoltaic energy, using equipment having a maximum cumulative output not exceeding 500 kilowatts. All electrical energy produced is sent to the provincial electrical grid for a credit toward the participant's energy costs relating to the electrical energy consumed by the participant. If the power supplied to the grid is more than what is taken from the grid, the participant will receive a credit that can be carried forward for up to one year to offset future energy costs. A participant will not receive any payment other than the credits reflected on its energy invoices.

It is also our understanding that the Ontario Power Authority ("OPA") and the Ontario Energy Board have developed a Renewable Energy Standard Offer Program for Ontario (the "Program"), designed to encourage and promote greater use of renewable energy sources 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.

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 a particular fact situation otherwise than in the form of an advance income tax ruling, the following general comments may be of assistance.

Depreciable Property

By virtue of paragraph 1102(1)(c) of the Regulations, the classes of property described in Schedule II to the Regulations ("Schedule II") only include property that was acquired by the taxpayer for the purpose of earning income. Provided that this requirement is satisfied, property, other than reconditioned or remanufactured equipment, used primarily (i.e., more than 50%) to generate electricity and/or heat may qualify for inclusion under paragraph (d) of Class 43.1 if it otherwise meets the requirements of a particular subparagraph thereto. Property that would otherwise be included in Class 43.1 because of paragraph (d) of that class may also be included in Class 43.2 of Schedule II provided that the other requirements of that class are met. Generally the requirements to be met for both classes are the same, except that property included in Class 43.2 must be acquired after February 22, 2005 and before 2012 and cannot have been included in any other class by any taxpayer before it was acquired.

Classes 43.1 and 43.2

In order for any property to be eligible for inclusion in Class 43.1 or 43.2 of Schedule II, 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. However, certain used equipment that is depreciable property that

A) was eligible for inclusion in Class 34, 43.1 or 43.2 of the vendor,

B) remains at the same location as used by the vendor, and

C) has been acquired by the taxpayer within five years from the time it became available for use to the vendor,

may be eligible for inclusion in Class 43.1. Used equipment meeting the requirements in B) and C) above may only be included in Class 43.2 if it was included in Class 43.2 by the vendor.

Pursuant to subsections 1102(21) and (22) of the Regulations, the capital cost of any used equipment that qualifies for inclusion in Class 43.1 or Class 43.2 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 or Class 43.2, as the case may be.

A property will not be considered to have been used for any purpose where it is new at the time that it is acquired but has been demonstrated for or tested by a prospective purchaser of that particular piece of equipment. In other words, 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 has been used regularly by the vendor for demonstration purposes is considered to have been used by the vendor.

Eligibility of the property for inclusion in Class 43.1 or 43.2 must generally be determined annually based on the use of the property in the particular taxation year. For example, a property described in subparagraph (d)(ix) of Class 43.1 must be used in the particular taxation year primarily to produce heat energy for use in an eligible activity and the fuel used must be an eligible fuel, such as wood waste. If, in a particular taxation year, a property included in Class 43.1 or 43.2 no longer satisfies the conditions for inclusion therein, subsection 13(5) of the Income Tax Act (the "Act") requires that the undepreciated capital cost of the property be transferred from Class 43.1 or 43.2, as the case may be, to the class in which the property would otherwise have been included as of the commencement of the particular taxation year. Similarly, if in a subsequent year, the property again satisfies the requirements for inclusion in Class 43.1 or 43.2, subsection 13(5) would apply to reclassify the property into the particular class as of the commencement of that year. For more detailed comments concerning the application of subsection 13(5), refer to the current version of IT-190, Capital Cost Allowance - Transferred and Misclassified Property.

Renewable Energy Property Included in Class 43.1

The following types of depreciable property may be included in Class 43.1 by virtue of paragraph (d) thereof, provided that the requirements described above have been met:

(a) Active solar heating equipment used by the taxpayer, or by a lessee of the taxpayer, primarily for the purpose of heating a liquid or gas used directly in an industrial process or in a greenhouse may qualify for inclusion in subparagraph (d)(i) of Class 43.1. Eligible property includes solar collectors, solar energy conversion equipment, solar water heaters, energy storage equipment, control equipment and equipment designed to interface solar heating equipment with other heating equipment, but does not include buildings.

(b) Fixed location wind energy conversion equipment that is part of a system that is used by the taxpayer, or by a lessee of the taxpayer, primarily for the purpose of generating electrical energy may qualify for inclusion in subparagraph (d)(v) of Class 43.1. Eligible property consists of a wind-driven turbine, electrical generating equipment and related equipment, including:

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

(ii) support structures, and

(iii) powerhouse complete with other ancillary equipment, and

(iv) transmission equipment (as used herein meaning such equipment up to the interface with either the distribution system or the local utility).

Assets that may be part of a wind energy conversion system that are not eligible to be included in Class 43.1 are electrical distribution equipment and facilities, other back-up electrical generating equipment, and other assets normally included in Class 10 or 17, e.g., vehicles, telephone equipment, access roads, sidewalks. However, electrical generating equipment described in subparagraph (a.1)(i) of Class 17 is eligible for inclusion in Class 43.1.

(c) Fixed location photovoltaic equipment that is used by the taxpayer, or by a lessee of the taxpayer, primarily for the purpose of generating electrical energy from solar energy may qualify for inclusion in subparagraph (d)(vi) of Class 43.1 provided it

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

(ii) consists 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 that are not eligible to be included in Class 43.1 are buildings, electrical distribution equipment and facilities, other back-up electrical generating equipment and other assets normally included in Class 10 or 17 (except electrical generating equipment described in subparagraph (a.1)(i) of Class 17 as noted above).

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

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

(iv) 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.

(d) Above-ground equipment that is used by the taxpayer, or by a lessee of the taxpayer, primarily for the purpose of generating electrical energy solely from geothermal energy may qualify for inclusion in subparagraph (d)(vii) of Class 43.1. Eligible property includes equipment consisting of pumps, heat exchangers, steam separators, electrical generating equipment and ancillary equipment used to collect the geothermal heat. However, buildings, transmission equipment, electrical distribution equipment and facilities, equipment designed to store electrical energy and other assets normally included in Class 10 or 17 (except electrical generating equipment described in subparagraph (a.1)(i) of Class 17 as noted above) are not eligible for Class 43.1.

(e) Equipment used by the taxpayer, or by a lessee of the taxpayer, primarily for the purpose of generating heat energy from certain specified fuels, including wood waste or bio-oil, may qualify for inclusion in subparagraph (d)(ix) of Class 43.1 provided that the heat energy is used directly in an industrial process, or in a greenhouse, of the taxpayer or lessee. Eligible equipment includes fuel handling equipment to the extent that it is used to upgrade the combustible portion of the fuel and control, feedwater and condensate systems, and other ancillary equipment. However, buildings or other structures, heat rejection equipment (such as condensers and cooling water systems), fuel storage facilities, other fuel handling equipment and electrical generating equipment, and property otherwise included in Class 10 or 17 are not eligible to be included in Class 43.1.

(f) Equipment used in a system of the taxpayer that converts wood waste or plant residue into bio-oil, may qualify for inclusion in subparagraph (d)(xi) of Class 43.1 if that bio-oil is used by the taxpayer, or by a lessee of the taxpayer, primarily for the purpose of generating electricity, or electricity and heat. However, equipment used for the collection, storage or transportation of wood waste or plant residue, buildings or other structures and property otherwise included in Class 10 or 17, are not eligible to be included.

(g) Property of a taxpayer that is part of a system that is used by the taxpayer or a lessee of the taxpayer primarily to produce, store and use biogas produced from manure by anaerobic digestion may qualify for inclusion in subparagraph (d)(xiii) of Class 43.1 if that biogas is used primarily by the taxpayer or the lessee to produce electricity, or to produce heat that is used directly in an industrial process or in a greenhouse. Qualifying property includes equipment that is an anaerobic digester reactor, a buffer tank, a pre-treatment tank, biogas piping, a biogas storage tank, biogas scrubbing equipment and electrical generating equipment. However, property that is used to collect manure, store manure (other than a buffer tank) or move manure to the system, equipment used to process the residue after digestion or to treat recovered liquids, auxiliary electrical generating equipment, buildings or other structures, transmission equipment, distribution equipment, equipment designed to store electrical energy, property normally included in Class 10 or Class 17 (except electrical generating equipment described in subparagraph (a.1)(i) of Class 17 as noted above) are not eligible for inclusion in Class 43.1.

(h) Electrical generating equipment and plant of a producer of hydro-electric energy acquired after December 10, 2001 for a hydro-electric installation that has a rated capacity not exceeding 50 MW at the installation site may qualify for inclusion in Class 43.1 under subparagraph (d)(ii) of that class. Eligible property includes a canal, a dam, a dyke, an overflow spillway, a penstock, a powerhouse (complete with electrical generating equipment and other ancillary equipment), control equipment, fishways or fish bypasses and transmission equipment, such as the transmission line up to the interface with the local electrical distribution system or the isolation switch of the local electrical utility system. Distribution equipment and property otherwise included in Class 10 or 17 (other than certain electrical generating equipment described in subparagraph (a.1)(i)) are not eligible for Class 43.1.

Certain terms used in Class 43.1, and referred to herein, are defined in subsection 1104(13) of the Regulations, in particular:

• "wood waste" includes scrap wood, sawdust, wood chips, bark, limbs, saw-ends and hog fuel, but does not include spent pulping liquor and any waste that no longer has the physical or chemical properties of wood;
• "spent pulping liquor" means the by-product of a chemical process of transforming wood into pulp, consisting of wood residue and pulping agents;
• "bio-oil" means liquid fuel that is created from wood waste or plant residues using a thermo-chemical conversion process that takes place in the absence of oxygen; and
• "plant residue" means the residue of plants that would, but for its use in a system to convert biomass into bio-oil, be waste material, but does not include wood waste or waste that no longer has the chemical properties of the plants of which it is a residue.

In addition, although not defined in the legislation, it is our interpretation that the term "industrial process" generally means an operation in which goods are manufactured or processed.

As noted previously, any renewable energy property that is eligible for inclusion in Class 43.1 as described in (a) to (h) above that is acquired after February 22, 2005 and before 2012 will be eligible for inclusion in Class 43.2 provided that it has not been included in another class by any taxpayer.

Capital Cost Allowance (CCA) Rate

Classes 43.1 and 43.2 provide for a CCA rate of 30% and 50%, respectively, calculated on a declining balance basis. However, by virtue of the "available for use rules" found in subsections 13(26) to (31) of the Act, CCA for a Class 43.1 or Class 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. Consequently, the rate of CCA in the year such property becomes available for use is 15% in the case of Class 43.1 property and 25% in the case of property included in Class 43.2.

Restriction on CCA

The specified energy property rules found in subsections 1100(24) to (29) of the Regulations may apply to restrict the amount of CCA that may be claimed for property included in Class 43.1 or 43.2. Where a depreciable property is specified energy property, CCA cannot be deducted to the extent that it would create or increase a loss from all such property owned by the taxpayer. This limitation on CCA that may be deducted will not apply where any of the following conditions are met:

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

(ii) the property is acquired to be used by the owner primarily for the purpose of gaining or producing income from a business, for example farming, 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), or

(iii) the 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 the principal business of which throughout the year was

• manufacturing or processing,
• mining, or
• the sale, distribution, or production of electricity, natural gas, oil, heat, or any other form of energy or potential energy.

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 a "specified energy property" for purposes of subsection 1100(24) of the Regulations and CCA on that property can not be deducted to the extent that it would create or increase a loss from all specified energy property owned by the taxpayer.

Summary

Where a person cannot be considered to have acquired a particular property for the purpose of earning income, for example, an individual who participates in the Ontario net metering program in respect of electricity generated for a personal residence, the property would not be eligible for inclusion in any CCA class.

In the case of a taxpayer operating a small business, such as a farm or a greenhouse, that has acquired an eligible property described above primarily to generate electricity for use in its own business and that participates in the Ontario net metering program, such property should be eligible for inclusion in either Class 43.1 or 43.2 provided that the requirements for inclusion in that class, as described above, have been met. As noted above, in such a case, the specified energy rules would not apply to limit the CCA that may be claimed in respect of the eligible property.

On the other hand, where a taxpayer that is not a PBC acquires a Class 43.1 or 43.2 property primarily to generate electrical energy for sale to the provincial power authority under a standard offer contract as part of the Program, the specified energy rules will apply to limit the CCA which may be claimed in respect of such property as described above.

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

Yours truly,

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch