4 April 2024 External T.I. 2024-1004651E5 - QZETMA: Battery Separators

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: Are battery separators manufactured for battery cells for zero-emission vehicles considered to be "integral components of the powertrain of the zero-emission vehicle, including batteries or fuel cells" for purposes of clause 5202(a)(i)(K) of the definition of qualified zero-emission technology manufacturing activities in the Regulations?

Position: Likely yes, if they are necessary for the functioning of the zero-emission vehicle's engine.

Reasons: Based on a textual, contextual and purposive analysis of the relevant provisions.

XXXXXXXXXX									2024-100465
										Nicki Verlinden

April 4, 2024

Dear XXXXXXXXXX,

Re: Manufacturing of battery separators for zero-emission vehicle batteries and the definition of qualified zero-emission technology manufacturing activities

We are writing in response to your email inquiry dated January 19, 2024. As discussed, we are replying only with respect to your question as to whether manufacturing activities relating to battery separators for electric vehicles could qualify as qualified zero-emission technology manufacturing activities (“QZETMA”) in section 5202 of the Income Tax Regulations, C.R.C., c.945, as amended (the “Regulations”). (footnote 1)

Our Comments

This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R12, Advance Income Tax Rulings and Technical Interpretations.

I. Regulation 5202 – definition of QZETMA

The relevant portion of the definition of QZETMA is as follows:

qualified zero-emission technology manufacturing activities means

(a) qualified activities that are

(i) performed in connection with the manufacturing or processing
of

(J) property that

(I) would be a zero-emission vehicle (as defined in subsection 248(1) of the Act if that definition were read without reference to its paragraphs (b) and (c)), or

(II) is described in subparagraph (a)(i) of Class 56 of Schedule II, and

(K) integral components of the powertrain of property included in clause (J), including batteries or fuel cells, and

(ii) not the manufacturing or processing of general purpose components or equipment which components or equipment are suitable for integration into property other than property described in subparagraph (i); (Emphasis added)

The applicable definition of a zero-emission vehicle (“ZEV”) in this context is a motor vehicle (footnote 2) that is a plug-in hybrid with a battery capacity of at least 7 kWh (footnote 3) or is fully electric, or powered by hydrogen. In addition, property that is described in subparagraph (a)(i) of Class 56 of Schedule II, is automotive equipment (footnote 4) (other than a motor vehicle) that is fully electric or powered by hydrogen. For purposes of the discussion below, both of these types of properties will be referred to as ZEVs.

II. Meeting the conditions in the definition of QZETMA – paragraph (a) of Reg. 5202

In order to meet paragraph (a) of the definition of QZETMA in the context of the manufacturing of battery separators for use in ZEVs, the taxpayer must determine that:

1. The activities it is carrying out are qualified activities.

2. The qualified activities are performed in connection with the manufacturing or processing of an integral component of the powertrain of the ZEV, including batteries and fuel cells.

3. The qualified activities are not the manufacturing or processing of general purpose components or equipment suitable for integration into property that is not described in subparagraph 5202(a)(i) of the definition of QZETMA (“Non-Qualifying Properties”).

In the discussion that follows, we will provide our general comments on each of the three conditions noted above.

1. Qualified Activities

Generally speaking, qualified activities are those that are performed in Canada directly in connection with the manufacturing or processing in Canada of goods for sale or lease (footnote 5) , as well as many other activities that are specifically listed in section 5202 of the Regulations when they are performed in Canada, in connection with the manufacturing or processing in Canada of goods for sale or lease. (footnote 6) Some of these specifically listed activities include: engineering design of products and production facilities; receiving and storing of raw materials; producing, assembling and handling of goods in process; and the inspecting and packaging of finished goods.

The definition of qualified activities also includes a list of excluded activities, such as: storing, shipping, selling and leasing of finished goods; purchasing of raw materials; administration, including clerical and personnel activities; as well as those listed under the definition of manufacturing or processing in subsection 125.1(3) of the Act, which among other things, includes construction and extracting minerals from a mineral resource.

For a complete list of qualified activities and excluded activities, please refer to the definition of qualified activities in section 5202 of the Regulations and the definition of manufacturing or processing in subsection 125.1(3) of the Act. It may also be helpful to refer to paragraphs 1.1 to 1.4, 1.9 to 1.17 and 1.33 to 1.37 of Income Tax Folio S4-F15-C1, Manufacturing and Processing - Canada.ca

2. In connection with the manufacturing or processing of an integral component of the powertrain of ZEV, including batteries and fuel cells

The definition of QZETMA requires that the battery separator being manufactured by the taxpayer is an “integral component” of the powertrain of the ZEV, including batteries or fuel cells.

The definition of QZETMA was introduced as part of the “Rate reduction for zero-emission technology manufacturing (“ZETM”) incentive”, announced in Budget 2021. (footnote 7) The Annex to that Budget stated the following regarding the eligibility of the ZETM activities:

This measure would apply in respect of income from the following zero-emission technology manufacturing or processing activities: […]

• manufacturing of zero-emission vehicles (i.e., plug-in hybrid vehicles with a battery capacity of at least seven kilowatt-hours, electric vehicles and hydrogen-powered vehicles) and the conversion of vehicles into zero-emission vehicles;
• manufacturing of batteries and fuel cells for zero-emission vehicles; […]

For each of the manufacturing activities described above, eligible activities would include the manufacturing of components or sub-assemblies only if such equipment is purpose-built or designed exclusively to form an integral part of the relevant system. For example, manufacturing of wind turbine rotor blades may be an eligible activity, but manufacturing of general use tires, fasteners, wiring, transformers, paint, piping or concrete would not. (Emphasis added) (footnote 8)

In light of the foregoing, it is our view that a property that is an integral component of a ZEV battery could meet the definition of clause 5202(a)(i)(K), as a property that is an integral component of the powertrain of the ZEV, including batteries and fuel cells.

The word “component” is not defined in the Act. The Oxford English Dictionary defines a “component” to be: A constituent element or part. It is generally understood that a battery separator is a component of a battery cell.

The word “integral” is also not defined in the Act. In Island Tug & Barge Ltd v. British Columbia, 2011 BCSC 396, the BC Supreme Court interpreted the word “integral” as follows (at para. 33):

“Integral” is defined in the Concise Oxford Dictionary, supra as “necessary to make the whole complete; fundamental; included as part of a whole; having all parts necessary to complete”.

In British Columbia Forest Products Ltd. v. Alberta (Assessment Appeal Board),1986 CarswellAlta 92, the Alberta Court of the Queen’s Bench had to interpret the word “integral” in the context of the Alberta Municipal Taxation Act, vis-à-vis determining whether cranes that were used for moving logs at a lumber mill were an integral part of the operational unit used in processing or manufacturing. The court analyzed the dictionary definition of the word “integral” at paragraphs 26 an 27, as follows:

The Shorter Oxford Dictionary defines “integral” as including:

Of or pertaining to a whole ... Belonging to or making up an integral whole; constituent ... necessary to the completeness of the whole ...

Webster's New Collegiate Dictionary defines “integral” as including:

Essential to completeness; constituent; formed as a unit with another part; lacking nothing essential.

In relying on these definitions of “integral”, the court concluded that because the mill could not function without the logs being moved to and from the storage area, the cranes were an integral part of the processing unit.

In your email you stated that the battery separator prevents short circuits and acts as the barrier between the ZEV battery’s anode and cathode, such that it is an essential component of the electric engine of the ZEV. Therefore, if the ZEVs in which the battery separators are ultimately installed would be unable to function without the battery separators, then in our view, the battery separators would be an integral component of the powertrain of the ZEV, including batteries, thus meeting the requirement in clause 5202(a)(i)(K) of the definition of QZETMA.

3. The manufactured components are not general purpose components that are suitable for integration into Non-Qualifying Properties

Pursuant to subparagraph (a)(ii) of the QZETMA definition, if the qualified activities are the manufacturing or processing of general purpose components or equipment suitable for integration into Non-Qualifying Properties, they will not qualify as QZETMA regardless of the fact that they meet the requirements in subparagraph (a)(i) of the QZETMA definition.

According to the Oxford English Dictionary:

• “suitable” means: Appropriate or fit for, or suited to, a purpose, occasion, person, etc.; fitting, right, proper; and
• “general purpose” means: having a range of potential uses or functions; not specialized in design.

In the Department of Finance’s explanatory notes to this exclusion, they use the example of the manufacturing of standard bolts that are integrated into turbines described in subparagraph 5202(a)(i) of the QZETMA definition as being excluded by subparagraph 5202(a)(ii).

In order to be “suitable” for integration into a Non-Qualifying Property, in our view, a property need not actually be integrated into a Non-Qualifying Property. The manufactured or processed property only needs to be appropriate or fit for integration into a Non-Qualifying Property regardless of the property in to which it is actually integrated.

Therefore, a component that does not have a range of uses and that is specialized in its design to achieve a specific purpose in respect of one of the properties included in subparagraph 5202(a)(i) of the definition of QZETMA would not be a general purpose component suitable for integration into Non-Qualifying Properties. As a result, the manufacturing of battery separators that are designed specifically for use in ZEVs (as opposed to other types of properties, such as cell phones, lawn mowers, laptops, etc.) would not generally be excluded from being QZETMA pursuant to subparagraph 5202(a)(ii) of the QZETMA definition.

We trust these comments will be of assistance.

Yours truly,

Kimberley Wharram
Manager, Resources Section
for Division Director
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 Unless otherwise stated, all references to a statute are to the relevant provisions of the Income Tax Act R.S.C. 1985 (5th Supp.), c.1, as amended (the “Act”) or to the Regulations.

2 A motor vehicle means an automotive vehicle designed or adapted to be used on highways and streets but does not include (a) a trolley bus, or (b) a vehicle designed or adapted to be operated exclusively on rails.

3 Subsection 1102(26) of the Regulations.

4 The CRA generally interprets “automotive” to mean “self-propelled”. See for example document 2011-0402501E5.

5 See paragraph (b) of the definition of qualified activities in section 5202 of the Regulations.

6 See paragraph (a) of the definition of qualified activities in section 5202 of the Regulations.

7 The purpose of that incentive is to reduce in the federal corporate tax rate for eligible zero-emission technology manufacturers from 15% to 7.5% and from 9% to 4.5%, depending on whether the corporate taxpayer is eligible for the small business rate.

8 Archived - Annex 6 - Tax Measures - Supplementary Information | Budget 2021 (canada.ca)