2019-0797491E5 CCA for Equipment Used to Produce Biofuels

Principal Issues: Will equipment used to produce biofuels and chemicals from municipal solid waste qualify for an inclusion in Class 43.2 or Class 53?

Position: Depending on the particular circumstances, it may qualify for an inclusion in Class 53.

Reasons: Text of the Regulations and the 2018 Fall Economic.

Author: Christov, Boriana
Section: Classes 43.1, 43.2, 53, subsections 1104(9) and 1104(13) of the Regulations; 2018 Fall Economic Statement

XXXXXXXXXX                                                                                                                                2019-079749
                                                                                                                                                        Boriana Christov
                                                                                                                                                        (438) 992 7393
April 3, 2019

Dear XXXXXXXXXX:

Re:  Equipment used for the production of biofuels

This is in response to your request from February 25, 2019 for our views on whether equipment used primarily (footnote 1) for the production of biofuels and chemicals from municipal non-organic solid waste (also known as equipment for waste gasification) is eligible for inclusion in Class 53 or Class 43.2 of Schedule II of the Income Tax Regulations (footnote 2) (the “Regulations”). In particular, the owner of the equipment (the “Taxpayer”) is a corporation carrying on a business in Canada which consists of chemically recycling XXXXXXXXXX carbon contained in XXXXXXXXXX waste and non-compostable residues. The Taxpayer purchases feedstock which is municipal waste and converts it into liquid biofuels and chemicals for sale to fuel or chemical distributors. XXXXXXXXXX.

You are of the view that subparagraph (d)(xvi) of Class 43.1 would otherwise apply but for the exclusion of equipment used primarily to generate producer gas that is to be converted into liquid biofuels or chemicals. In view of this exclusion, you would like to know whether such equipment may be nonetheless eligible for an inclusion in Class 53 of Schedule II of the Regulations.

Whether any particular piece of equipment qualifies for inclusion in one of the classes described in Schedule II of the Regulations is a question of mixed fact and law, which requires a review of all the facts of the situation. While we cannot confirm that a particular property will be eligible for inclusion in Class 43.2 or Class 53 of Schedule II to the Regulations we can provide some general comments, which we hope will be of assistance.

I.    OVERVIEW OF CLASSES 43.2 AND 53

The Income Tax Act (footnote 3) (the “Act”) and the Regulations include measures to encourage Canadian taxpayers to make investments in certain qualifying projects including clean energy generation and energy conservation projects, and to carry on manufacturing and processing activities in Canada.

A.    Class 43.1 and Class 43.2

An accelerated capital cost allowance (“CCA”) for investments in clean energy generation and energy conservation equipment is provided at the current CCA rates of 30% for equipment described in Class 43.1 and 50% for equipment described in Class 43.2 of Schedule II of the Regulations and both rates are applied on a declining balance basis. With some exceptions not relevant here, (footnote 4) generally property described in Class 43.1 would be included in Class 43.2 when acquired after February 22, 2005 and before 2025.

In order to be included in Class 43.2, the depreciable property must:

* be situated in Canada;

* be acquired by a taxpayer for use by the taxpayer for the purpose of earning income from a business carried on in Canada or from property situated in Canada, or the property must be acquired by a taxpayer in order to be leased to a lessee who will use the property for the same income earning purpose; and

* subject to certain exceptions, (footnote 5) not have been used for any purpose before the taxpayer acquired the property.

The Government of Canada’s 2018 Fall Economic Statement proposed additional measures to encourage certain capital investments. In particular, the proposal includes accelerated investment incentives that, among other things, allow businesses to immediately deduct the full cost of specified clean energy equipment which is described in Classes 43.1 and 43.2, and which is subject to certain conditions and limitations. The eligible property must be acquired after November 20, 2018 and it must be available for use before 2024 in order to qualify for this full expensing measure. For eligible property that is available for use after 2023 but before 2028, there is an enhanced CCA which will gradually decrease to nil for eligible property that becomes available for use in 2028. (footnote 6)

For more detailed information concerning Class 43.2, refer to Income Tax Folio S3‑F8‑C2, Tax Incentives for Clean Energy Equipment on the Canada Revenue Agency webpage. For more detailed information concerning the accelerated investment incentives included in the 2018 Fall Economic Statement, refer to https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/sole-proprietorships-partnerships/report-business-income-expenses/claiming-capital-cost-allowance/accelerated-investment-incentive.html.

B.    Class 53

On the other hand, certain properties used directly or indirectly by a taxpayer in Canada primarily in the manufacturing or processing goods for sale or lease, or leased by certain corporations to a lessee who can reasonably be expected to use, directly or indirectly, the property in Canada primarily in the manufacturing or processing of goods for sale or lease, may be eligible for an inclusion in Class 53 of Schedule II of the Regulations. The rate of the accelerated CCA for Class 53 is 50% which is applied on a declining balance basis.

The 2018 Fall Economic Statement proposed additional measures to encourage capital investments for properties described in Class 53. In particular, the proposal includes accelerated investment incentives that, among other things, allow businesses to immediately deduct the full cost of specified machinery and equipment that is primarily used for the manufacturing or processing of goods. The eligible property must be acquired after November 20, 2018 and it must be available for use before 2024 in order to qualify for this full expensing measure. For eligible property that is available for use after 2023 but before 2028, there is an enhanced CCA which will gradually decrease to nil for eligible property that becomes available for use in 2028. Some other conditions and limitations are described below.

II.   OUR COMMENTS

Subparagraph (d)(xvi) of Class 43.1 reads as follows:

equipment used by the taxpayer, or by a lessee of the taxpayer, primarily for the purpose of generating producer gas (other than producer gas that is to be converted into liquid biofuels or chemicals), including related piping (including fans and compressors), air separation equipment, storage equipment, equipment used for drying or shredding eligible waste fuel, ash‑handling equipment, equipment used to upgrade the producer gas into biomethane and equipment used to remove non‑combustibles and contaminants from the producer gas, but not including buildings or other structures, heat rejection equipment (such as condensers and cooling water systems), equipment used to convert producer gas into liquid biofuels or chemicals and property otherwise included in Class 10 or 17,

   [Emphasis added]

We agree with your view that equipment used primarily for the production of biofuels and chemicals from municipal solid waste would generally be excluded from inclusion in Class 43.2 because of the clear restrictions in subparagraph (d)(xvi) of Class 43.1 (see the underlined text above).

Although the Taxpayer’s equipment may not be eligible for Class 43.2, it may be eligible for inclusion in Class 53. For the present purposes, property that is machinery or equipment may be included in Class 53 if it is acquired after 2015 and before 2026 and it is not included in Class 29, but would otherwise be included in that Class if:

* subparagraph (a)(ii) of Class 29 were read without reference to “in Canadian field processing carried on by the lessee or;” and

* Class 29 were read without reference to its subparagraphs (b)(iv) to (vi) and paragraph (c).

Such property must be used directly or indirectly by the taxpayer in Canada primarily in the manufacturing or processing of goods for sale or lease, or leased by certain corporations to a lessee who can reasonably be expected to use, directly or indirectly, the property in Canada primarily in the manufacturing or processing of goods for sale or lease.

The expression “to be used directly or indirectly” refers to property acquired by the taxpayer for the purpose of being an integral and essential part of the taxpayer’s manufacturing or processing activities, as well as any ancillary equipment such as furniture and fixtures, repair and maintenance equipment and fire extinguishing equipment, which is acquired for use in those activities.

The Act does not define manufacturing or processing. However, subsection 1104(9) of the Regulations (which, among others, applies for the purposes of Classes 29 and 53) provides that “manufacturing and processing” excludes certain activities such as: operating an oil and gas well, extracting minerals, processing ore, producing industrial minerals, producing or processing electrical energy or steam for sale, processing natural gas by a public utility, processing heavy crude oil, or Canadian field processing.

In broad terms, the manufacture of goods normally involves the creation of something (for example, making or assembling machines, clothing, soup) or the shaping, stamping, or forming of an object out of something (for example, making steel rails, wire nails, rubber balls, wood moulding). On the other hand, processing of goods usually refers to a technique of preparation, handling, or other activity designed to effect a physical or chemical change in an article or substance, other than natural growth. Examples of such activities are galvanizing iron, creosoting fence posts, dyeing cloth, dehydrating foods, and homogenizing and pasteurizing dairy products.

Courts have determined that the taxpayer would be engaged in processing if the following two tests are met:

* there is a change in the form, appearance, or other characteristics of the goods subject to the operation; and

* the product becomes more marketable. (footnote 7)

Based on these judicial tests, it is probable that the production of biofuels and chemicals from municipal solid non-recyclable waste and non-compostable residue may generally be considered as manufacturing or processing. Therefore, if all other conditions of Class 53 are met, the machinery and equipment used in said production may be eligible for inclusion in that Class.

Further, provided that eligible equipment is acquired after November 20, 2018 and it becomes available for use before 2024 and provided that all other conditions are satisfied, the Taxpayer may fully deduct the cost of the capital property in its taxation year that includes the year of acquisition of the property. For example, this incentive is not available if the property is acquired from a non-arm’s length person or if it is acquired on a tax-deferred (roll-over) basis.

For more detailed information concerning manufacturing and processing, refer to Income Tax Folio S4-F15-C1, Manufacturing and Processing on the Canada Revenue Agency webpage.

Information concerning the 2018 Fall Economic Statement can be found on the Canada Revenue Agency webpage https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/sole-proprietorships-partnerships/report-business-income-expenses/claiming-capital-cost-allowance/accelerated-investment-incentive.html#Rules.

Yours truly,

Kimberley Wharram
Acting Manager
Resources Section
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy & Regulatory Affairs Branch

FOOTNOTES

Note to reader:  Because of our system requirements, the footnotes contained in the original document are shown below instead:

1     For the present purposes, the word “primarily” means more than 50%.
2     C.R.C. c. 945, as amended.
3     R.S.C. 1985, c. 1 (5th suppl.) as amended.
4     The following property only qualifies for an inclusion in Class 43.1: (i) mid‑efficiency, fully or partially fossil-fuelled cogeneration systems; (ii) electric vehicle charging stations set up to supply more than 10 kW but less than 90 kW of continuous power; and (iii) electrical energy storage equipment connected to one of the above systems and stand-alone electrical energy storage systems meeting particular efficiency requirements.
5     See paragraphs (b) and (e) of Class 43.1.
6     During the phase-out period the enhanced CCA rates are as follows: for eligible properties that are available for use in:
* 2024 and 2025 the rate is 75%;
* 2026 and 2027 the rate is 55%; and
* 2028 the enhanced CCA rate is nil.
7     See generally, Tenneco Canada Inc. v The Queen, 91 D.T.C. 5207 (F.C.A.) and more recently, Canada v. Repsol Energy Canada Ltd., 2017 F.C.A. 193.

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