Over the last several years, each Federal Budget has proposed a number of tax incentives to encourage clean energy generation and conservation, including gradually expanding the assets that are eligible for an accelerated capital cost allowance and allowing certain intangible project start-up expenses to be treated as “Canadian Renewable and Conservation Expenses” (as defined in the Income Tax Act (Canada) (the “Tax Act”)). Below is an overview of certain clean energy tax incentives and a summary of the clean energy related proposals in the 2010 Federal Budget and the 2011 Federal Budget.
Capital Cost Allowance - Overview
Under the Tax Act, in computing the income of a taxpayer from a business or property, no deduction shall be made in respect of any outlay, loss or replacement of capital, a payment on account of capital, or an allowance in respect of depreciation, obsolescence or depletion except as expressly permitted under the Tax Act.1 Notwithstanding this general limitation, paragraph 20(1)(a) of the Tax Act expressly permits a taxpayer to deduct an amount in respect of the capital cost of a depreciable asset, subject to the Regulations to the Tax Act (the “Regulations”). The amount that is permitted to be deducted is referred to as the “capital cost allowance” (“CCA”).2 Schedule II of the Regulations sets out 55 classes of property and each class is prescribed a maximum rate of CCA (i.e. the depreciation).3
Accelerated CCA for Clean Energy Equipment
Under the CCA regime, subject to the half-year rule, which limits the amount of CCA that can be claimed in the year an asset is acquired, Class 43.2 provides an accelerated CCA (i.e. 50% per year on a declining balance basis) for eligible clean energy generation and conservation equipment. Class 43.2 incorporates, by reference to Class 43.1, a detailed list of eligible equipment that generates or conserves energy by:
- using a renewable energy source (e.g. wind, solar, or small hydro);
- using fuels from waste (e.g. landfill gas, wood waste, or manure); or
- making efficient use of fossil fuels (e.g. high efficiency cogeneration systems that simultaneously produce electricity and useful heat).
Class 43.2 is available for equipment acquired on or after February 23, 2005 and before 2020. Subject to the detailed rules in the Regulations, the following equipment will qualify as Class 43.2 property:
- High efficiency cogeneration equipment
- Wind turbines
- Small hydroelectric facilities
- Fuel cells
- Photovoltaic equipment
- Wave and tidal power equipment
- Equipment that generates electricity using geothermal energy or eligible waste fuel (e.g. wood waste or landfill gas)
- Active solar equipment
- Ground source heat pump equipment
- District energy equipment that distributes thermal energy from cogeneration, ground source heat pumps, active solar systems or heat recovery equipment
- Equipment that generates heat for an industrial process or a greenhouse using an eligible waste fuel
- Heat recovery equipment that recovers waste heat from the generation of electricity or an industrial process
Fuels from Waste
- Equipment that recovers landfill gas or digester gas
- Equipment used to convert biomass into bio-oil
- Equipment used to produce biogas through anaerobic digestion
Under the CCA regime, subject to the half-year rule, Class 43.1 also provides an accelerated CCA (i.e. 30% per year on a declining balance basis) for eligible clean energy generation and conservation equipment. The eligibility criteria for Class 43.1 and 43.2 is generally the same, except that cogeneration systems that use fossil fuels must satisfy a higher efficiency standard to qualify as Class 43.2 equipment. Subject to the detailed rules in the Regulations, the following equipment will qualify as Class 43.1 property:
- Cogeneration and specified-waste fuelled generation systems;
- Active solar systems;
- Small-scale hydroelectric installations;
- Heat recovery systems;
- Wind energy conversion systems;
- Photovoltaic electrical generation systems;
- Geothermal electrical generation systems; and
- Specified-waste fuelled heat production equipment.
Class 43.2 v. Class 43.1
Often clean energy generation and conservation equipment will fall within both Class 43.1 and Class 43.2. Consequently, provided an asset satisfies the higher efficiency standards under Class 43.2, a taxpayer should deduct the higher CCA rate (i.e. 50% per year on a declining balance basis).
Canadian Renewable and Conservation Expenses and Flow-Through Shares
If the majority of tangible property in a project is eligible for inclusion under Class 43.1 or Class 43.2, certain intangible project start-up expenses (e.g. engineering and design work and feasibility studies) may be treated as “Canadian Renewable and Conservation Expenses” (“CRCE”) (as defined in the Tax Act). CRCE may be deducted in full in the year incurred, carried forward indefinitely for use in future years, or renounced to investors using "flow-through shares" (as defined in the Tax Act).
Under the Tax Act, generally, a corporation, the principal business of which is resource production or clean energy production, can issue “flow-through shares” (as defined in the Tax Act) to an investor pursuant to an agreement that provides that the corporation agrees to incur specified expenses and renounce the expenses to the investor.
2010 Federal Budget
The 2010 Federal Budget proposed to expand Class 43.2 to include: (i) a broader range of heat recovery equipment; and (ii) distribution equipment used in district energy systems that rely primarily on ground source heat pumps, active solar systems, or heat recovery equipment.
Provided these measures are enacted as law, these measures will apply to eligible equipment acquired on or after March 4, 2010 that were not used or acquired for use before March 4, 2010. Although these measures have not yet been enacted, generally, most taxpayers will take the position that the measures will eventually be enacted and, as a result, deduct the applicable CCA.
The 2011 Federal Budget
The 2011 Federal Budget proposes to further expand Class 43.2 to include equipment that is used to generate electrical energy in a process in which all or substantially all (i.e. 90%) of the energy input is from waste heat.
Eligible equipment will include electrical generating equipment, control, feedwater and condensate systems and other ancillary equipment, but not buildings or other structures, heat rejection equipment (such as condensers and cooling water systems), transmission equipment, or distribution equipment. In addition, any system using chlorofluorocarbons or hydrochlorofluorocarbons will not be eligible.
Provided these measures are enacted as law, these measures will apply to eligible equipment acquired on or after March 22, 2011 that was not used or acquired for use before March 22, 2011. Similar to the 2010 measures, although these measures have also not been enacted, generally, most taxpayers will take the position that the measures will eventually be enacted and, as a result, deduct the applicable CCA.
It is likely that the number of tax incentives encouraging clean energy generation and conservation will continue to grow. As a result, in order to maximize any tax savings, clean energy companies must be aware of the current and proposed clean energy tax incentives.