20 November 2008 External T.I. 2008-0296181E5 - renewable Energy Projects - Tidal Energy

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: Discussion of tax incentives available for renewable energy projects-- tidal wave energyprojects - tidal wave energy

Position: general discussion

XXXXXXXXXX 								2008-029618
									Lena Holloway
November 20, 2008

Dear XXXXXXXXXX

Re: Renewable Energy Projects- Tidal Energy

We are writing in response to your e-mail correspondence of October 7, 2008, requesting information on any special income tax considerations concerning tidal energy projects. In particular you indicated that you were interested in any information related to eligible expenditures (if any) that would qualify for renunciation under a flow-through share agreement.

Unless otherwise noted, all references herein are references to the Income Tax Act, R.S.C. 1985 (5th Supp.) c.1, (the "Act") as amended from time to time and consolidated to the date of this letter.

The 2007 Federal Budget Measures included a provision to add tidal wave energy equipment to Class 43.1 of Schedule II to the Income Tax Regulations (the "Regulations") relating to the capital cost allowance ("CCA") system, the details of which were released as part of the 2008 Federal Budget tabled on February 26, 2008 as follows:

"(10) Paragraph (d) of Class 43.1 in Schedule II to the Regulations is amended by adding the following after subparagraph (xiii):

(xiv) property that is used by the taxpayer, or by a lessee of the taxpayer, primarily for the purpose of generating electricity using wave or tidal energy (otherwise than by using physical barriers or dam-like structures), including support structures, control, conditioning and battery storage equipment, submerged cables and transmission equipment, but not including buildings, distribution equipment, auxiliary electricity generating equipment, property otherwise included in Class 10 and property that would be included in Class 17 if that class were read without reference to its subparagraph (a.1) (i)".

This draft legislation has not yet been passed but in general, when passed, these amendments to Class 43.1 will apply to property acquired after March 18, 2007.

Our Comments

Your letter requested information related to eligible expenditures (if any) that would qualify for renunciation under a flow-through share agreement. Such information requires a discussion of the relevant CCA regulations, Canadian renewable and conservation energy expenses ("CRCE") and Canadian exploration expenses ("CEE"). 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. Therefore while 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 to you.

CCA

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. Where a person cannot be considered to have acquired a particular property for the purpose of earning income, the property would not be eligible for inclusion in any CCA class. However if the above proposals become legislation then equipment acquired for the purpose of earning income and which meets the criteria described in proposed subparagraph (d) (xiv) of class 43.1 would be eligible for inclusion in CCA class 43.1. Where such wave or tidal energy equipment is acquired after February 22, 2005, it may be eligible for inclusion in Class 43.2. 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. In this regard we note that the 2007 Federal Budget proposes to extend eligibility for Class 43.2 to assets acquired before 2020. Property included in Class 43.2 is eligible for a 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 Act , CCA for a 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. A property that becomes available for use in the year is subject to the 50% rule found in subsection 1100(2) of the Regulations which would effectively reduce the write-off rate to one half the eligible amount in the first year of use. 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.

Where a taxpayer is not a principal business corporation ("PBC") and acquires a Class 43.1 property primarily to generate electrical energy for sale, the property will be considered a "specified energy property" for purposes of subsection 1100(25) of the Regulations and CCA on that property cannot be deducted to the extent that doing so would create or increase a loss from all such property owned by the taxpayer. In other words, the amount of CCA that may be claimed in a taxation year for a specified energy property is limited to the lesser of:

(i) the amount of CCA otherwise determined for such property, or

(ii) the taxpayer's net income (i.e. after deducting all expenses, other than CCA, related to earning such income) from all specified energy property of the taxpayer.

For these purposes, a 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.

CRCE

Canadian renewable and conservation energy ("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 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. Where expenses do qualify as CRCE, they are added to a taxpayer's CEE pursuant to paragraph (g.1) of that definition in subsection 66.1(6).

Flow-through shares

A taxpayer that qualifies as a PBC 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. For an informative discussion of the flow-through shares mechanism, we would like to refer you to the following website http://www.cra-arc.gc.ca/tx/bsnss/tpcs/fts-paa.

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