5 November 2007 External T.I. 2007-0250131E5 - Canadian renewable and conservation expense

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 expenses incurred in respect of a project using XXXXXXXXXX will qualify as CRCE and can be renounced to flow-through shareholders.

Position: Most of the expenses do not appear to qualify as CRCE and may not be renounced. General information provided with respect to the type of expenses that are eligible for CRCE.

Reasons: The expenses that were described generally related to the type of expenses that are specifically excluded under subsection 1219(2) of the Regulations.

XXXXXXXXXX 							Fiona Harrison
								2007-025013
November 5, 2007

Dear XXXXXXXXXX:

This is in response to your electronic mail of August 20, 2007, wherein you requested our comments in respect of "Canadian renewable and conservation expense" ("CRCE") that can be renounced to flow-through shareholders.

You have advised that your corporation qualifies as a "principal business corporation" as that term is defined in subsection 66(15) of the Income Tax Act (the "Act"). You have stated that your corporation will be involved in a project utilizing XXXXXXXXXX that will qualify as property described in subparagraph (d)(XXXXXXXXXX) of Class 43.1 of Schedule II of the Income Tax Regulations (the "Regulations"). You have requested our views as to whether certain expenses incurred in connection with this project will qualify as CRCE.

Our Comments

Written confirmation of the 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 submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. The following comments are, therefore, of a general nature only and are not binding on the Canada Revenue Agency.

CRCE is defined in subsection 1219(1) of the Regulations to mean an expense 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 qualify for inclusion in Class 43.1 or 43.2, if, among other things, the amount is 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.

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.

Examples of the types of expenses that are eligible for CRCE are described in subsection 1219(1) of the Regulations and include:

(a) expenses incurred for the purposes of making a service connection to the project for the transmission of electricity to a purchaser of the electricity, to the extent the expense was not incurred to acquire property;

(b) expenses incurred for the construction of a temporary access road to the project site;

(c) expenses incurred for a right of access to the project site before the earliest time at which a property described in Class 43.1 or 43.2 is used in the project for the purpose of earning income;

(d) expenses incurred for clearing land to the extent necessary to complete the project; and

(e) expenses incurred for process engineering for the project, including

(i) collection and analysis of site data,

(ii) calculation of energy, mass, water or air balances,

(iii) simulation and analysis of performance and cost of process design options, and

(iv) selection of the optimum process design.

Examples of the types of expenses that are not eligible for CRCE are described in subsection 1219(2) of the Regulations and 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 (b), (d) and (e) above as qualifying as CRCE;

B) financing and interest charges;

C) expenditures for the acquisition of, or the right to use land, except those described in (b), (c) or (d) above;

D) expenses for grading or levelling land or for landscaping, except those described in (b) above

E) amounts payable to a non-resident person or a partnership, other than a partnership all of the members of which are residents of Canada;

F) an expenditure that would be an eligible capital expenditure, except as described in (a) to (e) above;

G) amounts included in the cost of inventory;

H) an expenditure in respect of scientific research and experimental development;

I) amounts incurred, for a project, in respect of anytime at or after the earliest time at which the property described in Class 43.1 or Class 43.2 was used in the project for the purpose of earning income;

J) certain costs attributable to the period of construction; and

K) amounts incurred in respect of the administration or management of business of the corporation.

We would note that CRCE is limited to expenditures incurred in the development of projects that will generate energy by using depreciable property of Class 43.1 or 43.2. Expenditures incurred to develop new technologies or renewable energy equipment will not normally be eligible as CRCE. The incentives available for these activities are those provisions of the Act relating to scientific research and experimental development, which are found in section 37 and 127 of the Act.

With respect to your particular queries, it would appear that a majority of the expenses that you have listed would not qualify as CRCE. In this regard, we note that equipment costs will generally be included as the capital cost of depreciable property. In particular, the cost of XXXXXXXXXX may be included in the capital cost of depreciable property for Class 43.1 or Class 43.2 where it meets the requirements of subparagraph (d)(XXXXXXXXXX) of Class 43.1 or Class 43.2, as the case may be. The costs of acquiring an intellectual property or developing a patent for a limited period will generally be included in the capital cost of depreciable property as described in Class 14. Legal costs and other direct costs related to the foregoing would also generally be added to the capital cost of the particular depreciable property. These amounts would, therefore, not generally be eligible as CRCE, unless they are described in paragraphs (b), (d) and (e) of subsection 1219(1) of the Regulations. Further, an expense incurred to acquire a patent or other intellectual property that does not qualify as depreciable property described in Class 14 may qualify as an eligible capital expenditure. Accordingly, these amounts will also generally not qualify as CRCE, unless they are specifically described in subsection 1219(1) of the Regulations. Finally, office expenses, management expenses, accounting expenses, marketing expenses and most business travelling expenses will also generally not qualify as CRCE as they will be considered to be incurred in respect of the management or administration of the business. Generally, only expenses incurred in the pre-production development phase of the project will qualify as CRCE. Consequently, production costs, including product engineering costs, will generally not qualify as CRCE.

Where expenses do qualify as CRCE, they are added to a taxpayer's Canadian exploration expense ("CEE") pursuant to paragraph (g.1) of the definition "Canadian exploration expense" in subsection 66.1(6).

Flow-through shares

A taxpayer that qualifies as a "principal-business corporation", as defined in subsection 66(15), 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)) 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. Consequently, any CRCE eligible expenses incurred prior to this time would not be eligible for inclusion in a flow-through share financing.

In the context of renewable energy projects a principal-business corporation includes 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 or 43.2, 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 or 43.2,

or a corporation all or substantially all of the assets of which are shares of the capital stock or indebtedness of one or more principal-business corporations that are related to the corporation (otherwise than because of a right referred to in paragraph 251(5)(b)).

The determination of whether or not a corporation qualifies as a principal-business corporation depends on the facts of the particular situation. However, a corporation the principal business of which is developing new technologies or renewable energy equipment will not qualify as a principal-business corporation.

Finally, we note that there is no requirement that the project be approved by the CRA or by Natural Resources Canada, unless the project involves a "test wind turbine" as defined in subsection 1219(3) of the Regulations.

We trust that our comments will be of assistance.

Yours truly,

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