2014-0547911E5 FTS renunciations

Principal Issues: Whether the heat recovery application could be eligible for CRCE treatment and, if the project stops after feasibility study, whether the resource expenses will still remain eligible for renunciation to the FTS investors.

Position: Maybe.

Reasons: Law and fact.

Author: Agarwal, Lata
Section: 66, 66.1, 66.2, Regulations 1219, 8200.1, class 43.1 and class 43.2

XXXXXXXXXX
                                                                                                                                                   2014-054791
                                                                                                                                                   Lata Agarwal, CPA, CMA
                                                                                                                                                   MBA

December 29, 2014

Dear XXXXXXXXXX:

Re:  Eligibility of renounced expenses 

This letter is in response to your email dated September 29, 2014, in which you requested us to confirm whether the particular application in your client’s “waste heat to power project” (the “Project”) would be described in Class 43.1 of Schedule II of the Income Tax Regulations (the “Regulations”) so that the applicable expenditures would qualify as “Canadian renewable and conservation expense” (“CRCE”) as that term is defined in section 1219 of the Regulations.  In addition, you wish to clarify that, in case the Project does not proceed beyond the feasibility study stage, the resource expenses incurred up to that point would remain eligible for renunciation to the flow-through share (“FTS”) investors.  

OUR COMMENTS

This technical interpretation provides general comments about the provisions of the Income Tax Act (the “Act”) and related legislation.  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 70-6R6, Advance Income Tax Rulings and Technical Interpretations.

We note that the Technical Guide to Class 43.1 and 43.2 and the Technical Guide to Canadian Renewable and Conservation Expenses (CRCE) have recently been published by Natural Resources Canada.

Thermal waste electrical generation equipment is generally described in paragraphs (a) to (c) of Class 43.1 of Schedule II to the Regulations and is further explained in section 2.2 of the Technical Guide to Class 43.1 and 43.2.  In particular, subparagraph (a)(iii) of Class 43.1 includes heat recovery equipment, such as a waste heat boiler, that is used primarily for the purpose of conserving energy or reducing the requirement to acquire energy by extracting for reuse “thermal waste” generated by an electrical generation or cogeneration system.

In addition, subparagraph (c)(iii) of Class 43.1 includes equipment, such as a steam turbine generator, that is used to generate electrical energy in a process all or substantially all of the energy input of which is “thermal waste”, other than:

*     equipment that uses heat from a gas turbine in the first stage of a combined cycle system; and

*     equipment that, on the date of its acquisition, uses chlorofluorocarbons (CFCs) or hydrochlorofluorocarbons (HCFCs).

For these purposes, “thermal waste” is defined under subsection 1104(13) of the Regulations as waste heat energy extracted from a distinct point of rejection in an industrial process that would otherwise be vented to the atmosphere or transferred to a liquid and not be used for a useful purpose.  Based on our understanding, the waste heat energy extracted from a calcination system which would otherwise be vented to the atmosphere should qualify as “thermal waste”.  Consequently, provided that your client’s “waste heat to power system” meets all the requirements contained in paragraphs (a) to (c) of Class 43.1, the heat recovery equipment and the electrical generation equipment would be included in Class 43.2 where the equipment was acquired after February 22, 2005 and before 2020.  In this regard we note that Class 43.2 has a 50% CCA rate based on the declining balance method.

Additionally, section 1219 of the Regulations provides that in order for an expenditure to qualify as CRCE, a taxpayer must incur the expense in respect of the development of a project where it is reasonable to expect that at least 50% of the capital cost of the depreciable property to be used in the project would be the capital cost of any property that would qualify for inclusion in either Class 43.1 or 43.2 of Schedule II to the Regulations.

As noted in subsections 1219(1) and 1219(2) of the Regulations, not all intangible expenditures will necessarily be eligible as CRCE.  However, the fact that the development of a particular project is subsequently abandoned due to factors that were not foreseen at the time that the initial stages of the project development were undertaken will not necessarily preclude such expenditures from being treated as CRCE.  In such circumstances, it will be necessary to establish that at the time the expenditures were incurred it was reasonable to expect that at least 50% of the capital cost of the depreciable property to be used in the proposed project would be the capital cost of any property that is described in Class 43.1 and Class 43.2.

Where the expenses qualify as CRCE, the expenses will be considered to be Canadian exploration expense (CEE) under paragraph (g.1) of the CEE definition in subsection 66.1(6) of the Act.  In general, a taxpayer that qualifies as a “principal-business corporation” (“PBC”), as that term is defined in subsection 66(15) of the Act, is entitled to deduct CEE or to renounce it to investors by issuing FTS. 

We trust that these comments will be of assistance.

Yours truly,

Fiona Harrison, CPA, CA
Manager
Resources Section
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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