On October 29, 2013, Bill C-4, Economic Action Plan 2013 No. 2, received second reading in the House of Commons and was referred to committee. The legislation incorporates several tax measures announced in the 2013 federal budget and certain other previously announced amendments, including some changes that are beneficial to the renewable energy sector. In particular, the legislation expands the scope of certain existing energy systems that qualify for the enhanced capital cost allowance (“CCA”) deduction, and extends the application of the principal business exclusion from the specified energy property (“SEP”) rules to accommodate tiered partnership structures commonly used in developing renewable energy projects.
Accelerated CCA For Qualifying Energy Systems
A significant tax incentive available to taxpayers developing renewable energy projects is the accelerated CCA deduction available on property described in Class 43.1 or Class 43.2 of Schedule II to the Income Tax Regulations. In order to qualify for the accelerated CCA deduction, the energy project must fit into one of the specified types of renewable or clean energy systems listed in Class 43.1 or 43.2. Property that is part of a system described in Class 43.1 normally qualifies for a 30% CCA deduction. However, most property that would otherwise qualify under Class 43.1 and that is acquired after February 22, 2005 and before 2020 is included in Class 43.2 and qualifies for a 50% CCA deduction. The CCA deduction is restricted in the year the property is acquired to one-half of the normal deduction, and may also be subject to the SEP rules (discussed below).
Generally, the types of renewable and clean energy systems described in Class 43.1 that qualify for the accelerated CCA deduction have been expanded and updated periodically as new technologies evolve and are reviewed by staff at the Department of Natural Resources (Canada). As a result of the 2013 federal budget, the scope of some existing qualifying systems described in Class 43.1 has been expanded in three ways.
First, the category that includes biogas production equipment was expanded so that more types of organic waste can qualify the biogas system for the accelerated CCA deduction. Prior to the 2013 federal budget, eligible biogas production equipment was limited to equipment using sludge from an eligible sewage treatment facility, food and animal waste, manure, plant residue or wood waste. The result of 2013 budget changes is that biogas production equipment acquired after March 20, 2013 that uses pulp and paper by-products, beverage industry waste and wastewater (for example, winery and distillery wastes) or separated organics from municipal waste are now eligible for the accelerated CCA deduction.
Second, the range of cleaning and upgrading equipment used to treat eligible gases from waste (biogas, digester gas and landfill gas) that is eligible for the accelerated CCA deduction has been expanded. The result of 2013 budget changes is that all types of cleaning and upgrading equipment acquired after March 20, 2013 that are used to treat eligible gases from waste are now eligible for the accelerated CCA deduction.
Third, the list of equipment that can be included as part of a qualifying biogas production and storage system described in Class 43.1 has been expanded to include fans, compressor and heat exchangers.
The SEP Rules and Tiered Partnership Structures
The SEP rules in subsections 1100(24)-(29) of the Income Tax Regulations limit the CCA deductions that a taxpayer can claim on specified energy property, which includes property included in Class 43.1 and 43.2, to an amount not exceeding income generated from the property, unless the taxpayer fits into one of three exceptions. The most commonly used exception is the “principal business” exclusion, which applies to specified energy property owned by a corporation that satisfies a principal business test on an annual basis. Qualifying principal businesses for purposes of the test are the sale, distribution or production of electricity, natural gas, oil, steam, heat or any other form of energy or potential energy, manufacturing and processing, and mining operations. If a partnership owns the specified energy property, each member of the partnership must be a corporation that satisfies the principal business test.
A commonly used structure for owning and developing renewable energy projects is a tiered partnership structure, in which a single partnership (“Holding LP”) is organized for development activities, and then separate project limited partnerships (“Project LPs”) are established underneath the Holding LP for each energy project that proceeds. In the context of tiered partnerships, there has been some concern as to whether a Project LP can qualify for the principal business exclusion to the SEP rules since one of the members of the Project LP is not a corporation but another partnership (i.e., Holding LP). In October 2010, the Department of Finance issued a comfort letter recommending the accommodation of tiered partnership structures by extending the principal business exclusion to apply to such partnerships. Draft legislation first released on December 21, 2012 (and now included in Bill C-4) does so by amending the principal business exclusion to apply to partnerships each member of which is either (1) a corporation that satisfies the principal business test or (2) a partnership each member of which is a corporation that satisfies the principal business test.