18 December 2012 External T.I. 2012-0468301E5 - Clarification of Class 43.2 Project Eligibility

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 the use of cooking oil waste in the production of electrical energy meets the definition as "eligible waste fuel" under classes 43.1 and 43.2.

Position: No

Reasons: General information provided as cooking oil can be used as a feedstock for anaerobic digestion.

XXXXXXXXXX
2012-046830
J. Nichols

December 18, 2012

Dear XXXXXXXXXX:

RE: Clarification of Class 43.2 Project Eligibility

We are writing in reply to your email dated November 1, 2012, requesting clarification as to whether incentives provided in the Income Tax Act (the "Act") to encourage investments in energy efficiency and renewable energy projects may be available with respect to your company's process of creating a biodiesel from the use of cooking oil waste. You advise that it is intended that the biodiesel will be used to generate electricity in remote and other areas, as a substitute fuel for existing electricity power grids.

Our comments

Written confirmation of the tax implications inherent in particular transactions may only be provided by this Directorate where the transactions are proposed, and are the subject matter of an advance income tax ruling, submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Ruling, dated May 17, 2002. This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on the Internet at http://www.cra-arc.gc.ca. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office, a list of which is available on the "Contact Us" page of the CRA website. We are, however, prepared to provide the following general comments.

Taxpayers carrying out renewable energy and energy conservation projects may be able to deduct certain expenses incurred in the pre-production development phase of such projects. In this regard, 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 either Class 43.1 or 43.2 of Schedule II to the Income Tax Regulations (the "Regulations") may qualify as "Canadian renewable and conservation expense" ("CRCE") as defined in subsection 1219(1) of the Regulations if, among other things, the expense 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.

Expenses that qualify as CRCE are included in a taxpayer's Canadian exploration expense by virtue of paragraph (g.1) of the definition of that term in subsection 66.1(6) of the Act and may be deducted by the taxpayer in the taxation year they are incurred or carried forward indefinitely for deduction in subsequent taxation years. Alternatively, CRCE incurred by a "principal-business corporation", as defined in subsection 66(15) of the Act, may be renounced by that corporation to shareholders who have entered into a flow-through share agreement with the corporation.

It should be noted that CRCE and properties described in Classes 43.1 and 43.2 normally involve established technologies for clean energy generation or energy conservation. Expenditures incurred on or in respect of activities that involve the development of new clean energy generation or energy conservation technologies or advancements to such technologies may be classified as "scientific research and experimental development" (SRED) expenditures. The term "scientific research and experimental development" is defined in subsection 248(1) of the Act.

Subsection 1104(13) of the Regulations includes the various definitions that are relevant for CRCE and Classes 43.1 and 43.2.

The term "plant residue" is defined as the "residue of plants (not including wood waste and waste that no longer has the chemical properties of the plants of which it is a residue) that would otherwise be waste material and that is used

(a) in a system that converts biomass into bio-oil or biogas; or

(b) as an eligible waste fuel."

Since this definition requires that plant residue otherwise be waste material, if the residue is harvested for use as a feedstock, it will not meet the definition of "plant residue".

The term "eligible waste fuel" is defined to mean plant residue, biogas, bio-oil, digester gas, landfill gas, municipal waste, pulp and paper and wood waste.

The term "bio-oil" is defined to mean the liquid fuel created from wood waste or plant residue using a thermal-chemical conversion process that takes place in the absence of oxygen. Therefore, the biodiesel produced from your process will not qualify as bio-oil.

Paragraph (a) of Class 43.1 includes property that is electrical generating equipment, including fuel handling equipment that is used to upgrade the combustible portion of the fuel, where the equipment is part of a system that is used to generate electricity only or electricity and heat (co-generation) and the system only uses eligible waste fuel, fossil fuel or spent pulping liquor. Moreover, under paragraph (c) of Class 43.1, the equipment described in paragraph (a) must be part of a system that is owned by the taxpayer or a lessee of the taxpayer and used for the purposes described therein. Where a taxpayer owns equipment that converts plant residue into biodiesel and the equipment is part of the taxpayer's system that is used to generate electricity, the equipment may be considered as fuel handling equipment that is used to upgrade the combustible portion of the fuel and eligible for inclusion under paragraph (a) of Class 43.1.

Class 43.2 provides for an accelerated capital cost allowance rate of 50% (on a declining balance) for properties acquired after February 22, 2005 and before 2020 and that are otherwise described in Class 43.1.

We are also including certain information that may be useful should you consider modifying your system and processes.

Subparagraph (d)(ix) of Class 43.1 includes certain equipment used by the taxpayer, or by a lessee of the taxpayer, solely for the purpose of generating heat energy primarily from the consumption of eligible waste fuel (which as described above includes plant residue), and not using any fuel other than eligible waste fuel or fossil fuel. We note that your equipment would not currently qualify under this subparagraph as it is not being used to generate heat energy.

The term "biogas" is defined to include, among other things, gas produced by the anaerobic digestion of organic waste that is "food and animal waste". It is our view that cooking oil waste would generally qualify as "food and animal waste" which is defined as "organic waste that is disposed of in accordance with the laws of Canada or a province and that is

(a) generated during the preparation or processing of food for human or animal consumption;

(b) food that is no longer fit for human or animal consumption; or

(c) animal remains."

Equipment that is part of a system that is used by the taxpayer, or by a lessee of a taxpayer, primarily to produce and store biogas will qualify under subparagraph (d)(xiii) of Class 43.1. Where a taxpayer uses equipment primarily to produce biogas by the anaerobic digestion of cooking oil waste, the equipment may qualify for inclusion under Class 43.1 under this subparagraph.

Finally, we note that subsection 1104(17) of the Regulations prevents the inclusion of the capital cost of these properties in Class 43.1 or 43.2 if the property is not in compliance with environmental laws, by-laws and regulations at the time when the property becomes available for use.

We trust our comments will be of assistance.

Yours truly,

Fiona Harrison, C.A.
Manager
Resources Section
Income Tax Rulings Directorate
Legislative Policy & Regulatory Affairs Branch