30 September 2010 External T.I. 2010-0373951E5 - Wind energy conversion system

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: CCA classification of a wind energy conversion system.

Position: General comments provided
CRA PUBLICATIONS: 2007-025013, 2004-010360, 2006-016936

XXXXXXXXXX
									2010-037395
									Bob Naufal
									(613) 957-2097

September 30, 2010

Dear XXXXXXXXXX :

Re: Classification of wind turbines

We are writing in response to your letter dated June 28, 2010, wherein you requested confirmation of the capital cost allowance ("CCA") classification of certain energy efficient equipment. In your letter, you asked whether an addition of a solar panel to a wind turbine system would constitute a cogeneration system for Class 43.2 / Class 43.1 purposes. In our phone discussion of August 3, 2010 (Naufal / XXXXXXXXXX ), we advised you that a cogeneration system has certain specific requirements as outlined in paragraph (a) of Class 43.2 [or paragraphs (a) to (c) of Class 43.1], but that each of a wind turbine and / or solar energy panel could be considered a Class 43.2 / Class 43.1 property provided that they meet the conditions described in paragraph (b) Class 43.2 [or subparagraphs (d)(v) or (vi) of Class 43.1].

In addition, during our phone discussion, you informed us that your client is in the business of manufacturing and selling wind turbines to parties that use the wind turbines to generate electrical energy. In this regard, you have requested our comments on the income tax implications for purchasers of the wind turbines from a CCA perspective.

Our Comments

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 of an advance income tax ruling request, as described in Information Circular 70-6R5, dated May 17, 2002. The review of fact situations involving specific taxpayers and transactions or events that have already taken place is the responsibility of the local tax services office where the taxpayer resides and it is not the practice of the Canada Revenue Agency to comment on such situations when the identity of the taxpayers is unknown.

Capital cost allowance ("CCA")

By virtue of paragraph 1102(1)(c) of the Income Tax Regulations (the "Regulations"), only property that was acquired by a taxpayer for an income earning purpose would be eligible for CCA and included in the Classes described in Schedule II to the Regulations ("Schedule II"). Where a taxpayer 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.

Where the income earning requirement is met, a fixed location device that is a wind energy conversion system acquired by a taxpayer after February 22, 2005 and before 2020, that would otherwise be included in another Schedule II Class and that is used by a taxpayer, or by a lessee of the taxpayer, primarily for the purpose of generating electrical energy may qualify for inclusion under paragraph (b) of Class 43.2. Acquisitions of such property on or before February 22, 2005 would qualify for inclusion in Class 43.1 pursuant subparagraph (d)(v) of that Class.

Components of a wind energy conversion system that qualify for inclusion in Class 43.2 / Class 43.1 would generally consist of wind-driven turbine, electrical generating equipment and related equipment, including

(a) control, conditioning and battery storage equipment,

(b) support structures,

(c) powerhouse complete with other ancillary equipment, and

(d) transmission equipment,

Examples of assets that may be part of a wind energy conversion system but would not be eligible for inclusion in Class 43.2 / Class 43.1 include distribution equipment and auxiliary electrical generating equipment.

In addition, for any property to be eligible for inclusion in Class 43.2 or Class 43.1, the property must:

• be situated in Canada; and
• not have been used for any purpose before the taxpayer acquired the property.

In this regard, a property will not be considered to have been used for any purpose where it is new at the time that it is acquired. New equipment that is demonstrated for or tested by a prospective purchaser of that particular piece of equipment will not normally be considered to have been used for a purpose. Consequently, the testing and commissioning of an otherwise new system prior to the purchaser taking possession will not normally result in a finding that the property has been used prior to its acquisition. However, a property that is used regularly by the vendor for demonstration purposes is considered to have been used by the vendor.

Property included in Class 43.2 is eligible for a CCA deduction rate of 50 percent, while property included in Class 43.1 is eligible for a CCA deduction rate of 30 percent, each on the declining balance basis. However, by virtue of the "available for use rules" found in subsections 13(26) to (31) of the Income Tax Act (the "Act"), CCA for a Class 43.2 or 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 of acquisition is subject to a limitation of 50 percent of the CCA otherwise deductible in that first year as required by subsection 1100(2) of the Regulations. 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.

Restriction on CCA deduction

Subsection 1100(24) of the Regulations restricts the amount of CCA that may be claimed on property that is "specified energy property" as defined in subsection 1100(25) of the Regulations. Under subsection 1100(24) of the Regulations, the amount of CCA that may be claimed by a taxpayer in a taxation year for a specified energy property is restricted to the lesser of:

• the amount of CCA otherwise determined for such property, or
• the taxpayer's net income (after deducting all expenses, other than CCA, related to earning such income) from all specified energy property of the taxpayer.

In other words, CCA on a specified energy property cannot be deducted to create or increase a loss from the specified energy property that can be used to offset other sources of income.

Generally, pursuant to its definition in subsection 1100(25) of the Regulations, "specified energy property" includes inter alia property that is described in Class 43.2 or 43.1, such as a wind energy conversion system and its components. A particular property described in Class 43.2 or 43.1 would generally not be a specified energy property in the following circumstances:

(a) where it is expected that more than 50% of the energy produced by the particular property is to be used or consumed in earning income from either:

• another business of the owner carried on in Canada (not including the business of selling the energy generated by the particular property); or
• another property operated in Canada by the owner of the property; or

(b) to certain leasing situations where certain conditions are met.

In addition, a Class 43.2 / 43.1 property that was acquired (i) in a non-arm's length transaction, (ii) in the course of a divisive corporate reorganization, or (iii) as a replacement property would not be considered a specified energy property under certain conditions as described in subsections 1100(27) to (29) of the Regulations.

The determination of whether a particular property is a specified energy property can only be made following a review of the facts of a particular situation. It is our general view that where a taxpayer acquires a Class 43.2 or 43.1 property such as a wind energy conversion system, primarily to generate electricity for sale and not for consumption in a business or other property of the taxpayer, the property would be considered a specified energy property, and therefore subject to the CCA deduction restriction.

However, subsection 1100(26) of the Regulations provides that the CCA deduction restriction described above does not apply to:

(a) corporations whose principal business throughout the taxation year was:

(i) manufacturing or processing,

(ii) mining, or

(iii) the sale, distribution, or production of energy, or

(b) partnerships, each member of which is a corporation described in (a).

Canadian Renewable Conservation Expenses

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 (e.g. a wind farm 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 43.2 or 43.1, 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 (see below).

Examples of the types of expenses that are eligible for CRCE include amounts incurred by the taxpayer:

(a) for the purpose 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) for the construction of a temporary access road to the project site;

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

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

(e) 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,

(f) for certain drilling costs for the project; or

(g) for a test wind turbine that is part of a wind farm project.

Subsection 1219(3) of the Regulations defines a "test wind turbine" as a device that is a wind energy conversion system that would otherwise be included in Class 43.2 / Class 43.1 (see comments on CCA above) and meets the other conditions specified in subsection 1219(3) thereto. In this regard, determinations as to whether conditions relating to test wind turbine status have been satisfied in a particular situation are made by the Canada Revenue Agency in consultation with Natural Resources Canada.

Examples of the types of expenses that are not eligible for CRCE 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), (e), (f) or (g) above as qualifying as CRCE;

(b) financing and interest charges;

(c) administration and management expenses;

(d) expenses included in the cost of inventory of the taxpayer;

(e) an expenditure on or in respect of scientific research and experimental development;

(f) amounts paid to a non-resident person or a partnership of which one or more of the members are not a resident of Canada; and

(g) costs related to the acquisition or use of land, as well as the grading and levelling of land, except those described in (b) to (d) above as qualifying as CRCE.

Expenses that qualify as CRCE may be deducted by taxpayers 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.

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.

We trust that our comments, provided in accordance with paragraph 22 of Information Circular 70-6R5, will be of assistance.

Yours truly,

Fiona Harrison
Manager
Resources Industries Section
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch