17 February 2011 Internal T.I. 2010-0381471I7 - Farming - From hog waste to methane to electricity

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 activities constitute "farming" for the purposes of the Income Tax Act.

Position: See response.

Reasons:	See response.

									February 17, 2011

	London Tax Services Office				HEADQUARTERS
	Specialist - Agriculture, Aquaculture		André M. Gallant
	   and Fisheries						(613) 957-8961
	Technical Applications and Valuations Division
	Audit Professional Services Directorate
	Attention : Mr. William MacGregor
									2010-038147

Farming - From Hog Waste to Methane Gas to Electrical Energy

This is in response to your email of September 23, 2010, with which you enclosed correspondence you received from XXXXXXXXXX , regarding whether certain activities would constitute "farming" for the purposes of the Income Tax Act (the "Act").

As further amplified as a result of several telephone conversations (Gallant/MacGregor; and Gallant/XXXXXXXXXX ), the situation being envisaged is described below.

Hog producers use hog waste to produce methane gas which is either sold in bottles or used to generate electrical energy. If the methane gas is used the generate electricity, the electrical energy produced is either sold to third parties or used by the hog producers in their farming operations. According to the Ontario Power Authority's most recent Bi-Weekly FIT and microFIT Report, there were 100 applications in Ontario for bioenergy projects (biogas, biomass and landfill) as of January 21, 2011, compared to 3,820 applications for Solar PV, 95 for hydroelectric and 257 for wind power.

The hog waste/methane/electrical energy process was recently described in an article by The Associated Press entitled "A first for SC [South Carolina]: Electricity from hog waste" as follows:

"Officials with Santee Cooper, Environmental Fabrics Inc., a firm based in Gaston, S.C., and Clemson University on Monday announced the construction of a new plant to generate electricity from the methane released by hog waste.

The methane digester will be built on a Williamsburg County hog farm and the electricity generated will be used by customers of Santee Cooper, the state-owned utility.

Environmental Fabrics is building the methane digester that officials say will produce enough electricity to power 90 South Carolina homes.

The company, based just outside Columbia, has installed more than 600 methane digesters around the world, 250 of them in the United States....

The utility has 197 megawatts of renewable generation either online or under contract, said Marc Tye, Santee Cooper's vice president of conservation and renewable energy.
"Our electricity includes power generated from landfill biogas, forest-waste biomass, solar and wind, and now we can add agricultural biogas to the lineup," he said.

Once the methane plant is operational, it will be owned by Environmental Fabrics which will sell the power to the utility.

The operation uses bacteria in a process called anaerobic digestion to recover methane from heating and mixing hog manure in an earthen, insulated covered lagoon. Excess liquid from the process is used for organic fertilizer.

Officials say the project holds promise for other agricultural applications and helps the environment by keeping methane out of the air.

The Environmental Protection Agency says methane can remain in the atmosphere as long as 15 years and is 20 times more effective at trapping heat than carbon dioxide.

... " [Published by both www.bloomberg.com on January 31, 2011; and www.farms.com on February 1, 2011]

While it is recognized that hog producers derive income from farming activities, your question concerns whether the portion of income derived from the sale of methane gas in bottles and from the sale of electrical energy produced using methane gas is also considered income from farming activities for the purposes of the Act.

OUR COMMENTS

Whether or not a taxpayer's business operations are considered to be "farming" for the purposes of the Act is a question of fact. The word "farming" is given a wide definition by subsection 248(1) of the Act. It includes tillage of the soil, the raising or exhibiting of livestock, the maintenance of horses for racing, the raising of poultry, the keeping of bees, fur farming, dairy farming and fruit growing. As indicated in Interpretation Bulletin IT-433R, Farming or Fishing -Use of Cash Method, this definition is not exclusive and would also include tree farming, the operation of a wild game reserve, a mechanical egg hatching operation, and the cultivation of crops in water and hydroponics. In certain factual circumstances, farming also includes raising fish, market gardening, and the operation of nurseries and greenhouses.

The Canadian Oxford dictionary ("Oxford") defines a "farm" as an area of land, and the buildings on it, used for growing crops, rearing animals etc. A "farmer" is defined in Oxford to be a person who farms land or rears certain animals. In the case of De Cloet Ltd. v. Minister of National Revenue (89 DTC 207), the Court noted that "[a]gricultural farming involves the whole aspect of commercial production of any crop or plant which has economic value".

However, farming generally does not include the manufacturing or processing ("M&P") of agricultural products unless the activities are incidental to the farming activity (see e.g. Interpretation Bulletin IT-145R (Consolidated), Canadian Manufacturing and Processing Profits - Reduced Rate of Corporate Tax, at paragraph 7).

Assuming that a taxpayer's hog producing operation is farming business, one would have to determine whether income from certain activities connected with hog producing activities such as the sale of methane gas produced by hog waste or electrical energy produced from such methane gas is also income from the taxpayer's farming business. In a situation where a taxpayer is actively involved in a farming business and the taxpayer also derives income from other activities that, if they are considered alone would not constitute farming, whether or not the income from the other activities can be regarded as farming income would generally depend on whether the other activities are incidental to the farming operations or are in fact a separate business. The income from the other activities would generally be considered farming income if they are incidental to the farming business operations. The expression "incidental" implies a subordinate relationship or "having a minor role in relation to". Factors that may be relevant in the determination of whether particular activities are incidental to other types of activities that are farming would include the quantum of income generated and the capital or labour invested in the two types of activities.

If the particular activities constitute a separate business, the income from those activities would not be farming income. Whether the other activities are part of a farming operation or a separate business is a question of fact, which depends upon the circumstances of the case. As indicated in Interpretation Bulletin IT-206R, Separate Businesses, in general terms, if a taxpayer's business operations are so interlaced, interdependent and interconnected that it is virtually impossible to separate one operation from the other, then there is only one business being carried on (see also e.g. Du Pont Canada Inc. v. The Queen, 2001 D.T.C. 5269 (FCA)). Generally, non-farming activities would be considered to be part of the farming operation where the taxpayer carries on a bona fide farming operation; the activities are related to the taxpayer's other farming activities; the activities are undertaken on a small scale; and the income generated by these activities is incidental to the taxpayer's other farming revenue.

In a situation where there is one business but the operations consist of, say, two types of activities, one type that is in the nature of farming and the other type that is not, the issue that arises is whether the business is a farming or non-farming business. This is a question of fact to be resolved by a review of all surrounding circumstances, including factors such as the capital and time invested in and the income derived from each type of activities. Thus, if the farming activities are simply incidental to the non-farming activities, the income from such activities would not be farming income.

We trust that these comments will be of assistance.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the CRA's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. You should make requests for this latter version to Mrs. Céline Charbonneau at (613) 957-2137. A copy will be sent to you for delivery to the client.

Yours truly,

S. Parnanzone
Manager
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch