Principal Issues: In hypothetical situation 1, whether a digester used to produce biogas from sludge from a municipal sewage facility could qualify as class 43.2 property, pursuant to any of subparagraphs (d)(viii), (ix) and (xiii) of class 43.1? In hypothetical situation 2, whether a wood boiler generating heat energy from the consumption of chopped wood, grown solely for that purpose (sometime referred to as "energy crop"), could qualify as class 43.2 property pursuant to subparagraph (d)(ix) of class 43.1 or on the basis of CRA's technical interpretation 2008-0276761E5?
Position: Situation 1. May qualify. Situation 2. Would not qualify.
Reasons: Situation 1. Pursuant to subparagraph (d)(xiii) of class 43.1, if specified conditions are met. Situation 2. The technical interpretation is not applicable in this situation and such energy crop does not appear to meet NRCan's definition of wood waste.
XXXXXXXXXX 2010-038523 Marc LeBlond
January 11, 2011
Dear Madam,
Subject: Eligibility for Classes 43.1 or 43.2
This is in response to your letter of October 27, 2010, in which you requested our comments on the above subject regarding the two projects described below.
Unless otherwise indicated, all statutory references herein are to the provisions of the Income Tax Act (the "Act").
It appears to us that the situations described in your letter and hereinafter summarized could constitute actual situations involving taxpayers. As stated in Information Circular 70-6R5, it is not the practice of the Directorate to provide comments regarding proposed transactions otherwise than through advance rulings. If your situation involved specific taxpayers and one or more transactions, you should submit all relevant facts and documents to the appropriate Tax Services Office for its opinion. However, we can offer the following general comments that we hope may be helpful to you. It should be noted that the application of one or more provisions of the Act generally requires the analysis of all facts relating to a particular situation. Accordingly, and in light of the fact that your letter only very briefly describes a hypothetical particular situation, our comments below may not be fully applicable in a particular situation.
The Projects
Project # 1
- A corporation (the "Corporation") has entered into agreements with certain municipalities to acquire sludge from them from water treatment plants.
- The sludge in question is introduced into a digester.
- The digestion process produces two components: gas and digestate.
- The gas is stored by the Corporation and sold to its customers to produce thermal energy.
- With respect to the digestate, the Corporation enters into agreements with farmers and spreads the digestate on agricultural land.
Project # 2
- The Corporation proposes to start a new thermal energy project.
- The Corporation will plant fast-growing trees, such as poplar, on land acquired by the Corporation.
- Sludge from municipal water treatment plants would be used as fertilizer for that crop.
- After two or three years of growth, the poplars will be harvested, chipped and burned in a biomass boiler to provide energy in the form of heat to various clients, XXXXXXXX .
Your Questions and Positions
You asked us whether the property related to the two projects, namely the digester, in Project # 1, and the biomass boiler, in Project # 2, could be Class 43.1 or 43.2 property, as described in Schedule II of the Income Tax Regulations (the "Regulations"), to the Corporation respecting its eligibility for the "flow-through share" program provided for in the Act.
Regarding the property related to Project #1, based on the changes proposed by the 2010 Federal Budget, you believe that the digester related to this project could be property included in Class 43.2 in Schedule II to the Regulations ("Class 43.2").
In your opinion, the digester could be property in that Class since it meets the conditions of:
- subparagraph (d)(viii) of Class 43.1 in Schedule II to the Regulations ("Class 43.1"), as it refers to digester gas;
- subparagraph (d)(ix) of Class 43.1, provided that the thermal energy is used directly in an industrial process or greenhouse, given that this project relates to "eligible waste fuel" as defined in subsection 1104(13) of the Regulations, which includes "biogas"; or,
- subparagraph (d)(xiii) of Class 43.1 as it applies to biogas.
With regard to Project #2, you are of the view that the biomass boiler linked to this project could be a Class 43.2 property for one of the following reasons:
- The biomass boiler meets the conditions provided for in subparagraph (d)(ix) of Class 43.1, provided that the thermal energy produced is used directly in an industrial process or a greenhouse, since this project involves the consumption of "eligible waste fuel" as defined in subsection 1104(13) of the Regulations.
- Technical Interpretation 2008-0276761E5 (the "2008 Technical Interpretation") of the Canada Revenue Agency ("CRA"), dated May 11, 2009, specifies that a biomass heating system would be eligible under subparagraph (d)(ix) of Class 43.1.
Our Comments
General Comments
In general, subsection 66.1(2) provides that a "principal-business corporation" (as defined in subsection 66(15)) may deduct in computing its income for a taxation year its "Canadian exploration expense" ("CEE"), as defined in subsection 66.1(6), which includes, among other things, its "Canadian renewable and conservation expense" ("CRCE") under paragraph (g.1) of the definition of CEE in subsection 66.1(6).
A "principal-business corporation" may, in general, instead of deducting in computing its income for a particular taxation year its CEE and, in particular, its CRCE, renounce CEE under a "flow-through share" agreement (as defined in subsection 66(15).
The definition of "principal-business corporation" in subsection 66(15) (as proposed by subsection 63(1) of the August 27, 2010 legislative proposals, applicable to the 2004 and subsequent taxation years) provides that a principal-business corporation is a corporation the principal business of which is any of, or a combination of, the activities described in paragraphs (a) to (i) of subsection 66(15). For the purposes of that definition, the relevant activities for purposes of the definition are:
(h) the generation or distribution of energy, or the production of fuel, using property described in Class 43.1 or 43.2 of Schedule II to the Income Tax Regulations, and
(i) the development of projects for which it is reasonable to expect that at least 50% of the capital cost of the depreciable property to be used in each project would be the capital cost of property described in Class 43.1 or 43.2 of Schedule II to the Income Tax Regulations, [emphasis added]
CRCE is defined in subsection 1219(1) of the Regulations as follows:
Subject to subsections (2) to (4), for the purpose of subsection 66.1(6) of the Act, Canadian renewable and conservation expense means an expense incurred by a taxpayer, and payable to a person or partnership with whom the taxpayer is dealing at arm’s length, in respect of the development of a 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 be the capital cost of any property that is included in Class 43.1 or 43.2 in Schedule II, or that would be so included if this Part were read without reference to this section, and includes such an expense incurred by the taxpayer… [emphasis added]
Each of Class 43.1 and 43.2 provides for accelerated capital cost allowance ("CCA") at a rate of 30% and 50%, respectively, in respect of certain energy conservation property.
Class 43.1 provides accelerated CCA for property acquired before February 23, 2005. Class 43.2 generally applies to Class 43.1 property acquired after February 22, 2005 and before 2020. The eligibility criteria for Class 43.1 and Class 43.2 are generally the same, except for fuel-specific cogeneration systems.
Annex 4 to "Tax Measures: Supplementary Information" of the 2008 Budget Plan sets out proposed legislative changes (applicable after February 25, 2008) relating to biogas equipment and waste-to-energy technologies, including the following:
[...]
Biogas Production Equipment
Class 43.2 includes equipment used to produce biogas through anaerobic digestion of specified organic wastes. A biogas plant consists primarily of a large heated airtight tank in which bacteria act on the organic waste to produce a gas composed mainly of methane. The gas is cleaned and can then be burned, like natural gas, to produce electricity or heat. Biogas facilities contribute to a reduction in greenhouse gas emissions both by capturing and burning methane, a potent greenhouse gas, and by potentially displacing the use of fossil fuels for energy generation. Further processing of the residual waste from biogas production may be undertaken to improve its quality for use as fertilizer.
Using a variety of feedstocks in an anaerobic digester can improve its efficiency by increasing the amount of biogas produced from a given amount of input, making the project more economic and further encouraging the use of fuel from waste. Budget 2007 announced an expansion of the list of feedstocks for eligible biogas production systems from manure to include food waste, plant residue and wood waste. Budget 2008 proposes to further expand this list to include animal matter, which is a good source of biogas, and sludge from a licensed sewage treatment facility, which can help stabilize the biogas production process. To ensure environmental and health standards are met, eligibility will be conditional on such inputs being disposed of in accordance with applicable federal and provincial laws.
[...]
Waste-To-Energy Applications—User Restrictions
…There are, however, several instances where the heat output or fuel produced from waste is required to be used for a specified purpose by a taxpayer:
- Thermal energy systems that generate heat from the combustion of specified fuels from waste are currently eligible for Class 43.2 only if the heat is used directly in an industrial process, or in a greenhouse, of the taxpayer.
[...]
- Biogas production equipment is eligible for Class 43.2 only if the taxpayer is also the user of the biogas and uses it to produce electricity, heat for use in an industrial process or a greenhouse, or both.
Budget 2008 proposes to expand the eligibility criteria of Class 43.2 for equipment used to produce heat from waste sources and equipment used to produce bio-oil by removing the requirement that the industrial process, greenhouse, electrical generating facility, or cogeneration facility be operated by the taxpayer. Allowing the taxpayer to sell the bio-oil or heat from waste sources to third parties for the designated uses is consistent with the intent of Class 43.2 in diverting materials that would otherwise be waste into the energy stream. …
Budget 2008 also proposes to remove the requirements that biogas produced by a taxpayer’s eligible anaerobic digester system be used by the taxpayer and that it be used to produce heat for use in an industrial process or a greenhouse or to produce electricity. …
[Emphasis added]
For the purposes of this discussion, it appears to us that the relevant parts of Class 43.1 (as amended by subsection 142(5) of the August 27, 2010 legislative proposals and applicable to property acquired after February 25, 2008) are as follows:
Class 43.1
Property, other than reconditioned or remanufactured equipment, that would otherwise be included in Class 1, 2, 8 or 48 or in Class 17 because of paragraph (a.1) of that Class
[...]
(d) that is
[...]
(viii) equipment used by the taxpayer, or by a lessee of the taxpayer, primarily for the purpose of collecting landfill gas or digester gas, including such equipment that consists of piping (including above or below ground piping and the cost of drilling a well, or trenching, for the purpose of installing that piping), fans, compressors, storage tanks, heat exchangers and other ancillary equipment used to collect gas, to remove non-combustibles and contaminants from the gas or to store the gas, but not including property otherwise included in Class 10 or 17,
(ix) equipment used by the taxpayer, or by a lessee of the taxpayer, primarily for the purpose of generating heat energy from the consumption of eligible waste fuel, and not using any fuel other than eligible waste fuel or fossil fuel, if the heat energy is used directly in an industrial process, or in a greenhouse, including such equipment that consists of fuel handling equipment used to upgrade the combustible portion of the fuel and control, feedwater and condensate systems, and other ancillary equipment, but not including buildings or other structures, heat rejection equipment (such as condensers and cooling water systems), fuel storage facilities, other fuel handling equipment and electrical generating equipment, and property otherwise included in Class 10 or 17,
[...]
(xiii) property that is part of a system that is used by the taxpayer, or by a lessee of the taxpayer, primarily to produce and store biogas, which property includes equipment that is an anaerobic digester reactor, a buffer tank, a pre-treatment tank, biogas piping, a biogas storage tank and a biogas scrubbing equipment, but not including
(A) property (other than a buffer tank) that is used to collect, move or store organic waste,
(B) equipment used to process the residue after digestion or to treat recovered liquids,
(C) buildings or other structures, and
(D) property otherwise included in Class 10 or 17,
[Emphasis added]
Our Comments on Project # 1
Based on the brief description of Project #1, it is possible that the gas production digester involved in this project constitutes Class 43.2 property pursuant to subparagraph (d)(xiii) of Class 43.1. Our conclusion is based on the following observations.
A prerequisite for the application of subparagraph (d)(xiii) of Class 43.1 is that biogas be produced and stored. Subsection 1104(13) of the Regulations defines certain terms that are relevant in determining whether a property is property included in Class 43.1 or Class 43.2.
The term "biogas" is defined in subsection 1104(13) of the Regulations (as proposed by subsection 127(2) of the August 27, 2010 legislative proposals applicable to property acquired after February 25, 2008) ("Biogas 2008"), as follows:
…[T]he gas produced by the anaerobic digestion of organic waste that is sludge from an eligible sewage treatment facility, food and animal waste, manure, plant residue or wood waste.
[Emphasis added]
It follows from this definition that, in order for a property to be a Class 43.1 property, by virtue of subparagraph (d)(xiii) of that class, it is essential that the gas be produced using an anaerobic digester and from organic wastes such as, for example, sludge from eligible sewage treatment facilities.
Subsection 1104(13) of the Regulations defines "eligible sewage treatment facilities" (as proposed by subsection 127(2) of the August 27, 2010 legislative proposals applicable to property acquired after February 25, 2008) as follows:
…[A] waste management facility that is situated in Canada and for which a permit or licence is issued under any law of Canada or of a province.
In our view, based on the general comments noted above and the brief description of Project #1 that you have submitted to us, the digester related to gas production involved in this project could be included in Class 43.2 by virtue of subparagraph (d)(xiii) of Class 43.1 if the following conditions are satisfied:
(1) The digester is part of a system used by the taxpayer, or its lessee, primarily to produce and store Biogas 2008 produced from organic waste such as sludge from "eligible sewage treatment facilities”;
(2) The digester is an anaerobic digester reactor;
(3) The digester is not property described in clauses (A) to (D) of subparagraph (d)(xiii) of Class 43.1;
(4) The digester is located in Canada; and,
(5) Corporation acquires a new digester to use for the purpose of earning income from a business carried on in Canada or income from property situated in Canada.
Our Comments on Project # 2
In our view, the 2008 Technical Interpretation is not relevant in determining whether the biomass boiler related to thermal energy generation, respecting Project #2, could be included in Class 43.2 pursuant to subparagraph (d)(ix) of Class 43.1. We believe that the biomass boiler related to thermal energy generation respecting Project 2 would not qualify for inclusion in Class 43.2 as it is not included in subparagraph (d)(ix) of Class 43.1. Our conclusions are based on the following observations.
The 2008 Technical Interpretation
In the 2008 Technical Interpretation, we confirmed that in general, a biomass heating system could be included in Class 43.2, by virtue of sub-paragraph (d)(ix) of Class 43.1, under certain conditions, such as:
[TaxInterpretations translation] The heating system is used by the Taxpayer primarily to produce thermal energy through the consumption of an "eligible waste fuel" i.e., for example, wood pellets must be the primary fuel producing the thermal energy used for eligible purposes.
The 2008 Technical Interpretation also states that [TaxInterpretations translation] "According to NRCan, wood pellets qualify as "wood waste" for the purpose of the definition of "eligible waste fuel" in subsection 1104(13) of the Regulations.” In that regard, we refer you to CRA Technical Interpretation 2005-0151611E5.
Wood pellets are a by-product of wood waste. Natural Resources Canada ("NRCan") describes this product on its website (footnote 1) as follows:
[TaxInterpretations translation] Pellet manufacturers recover by-products (such as wood waste) and process them into pellets of the same size (typically 1/4 inch or 6 mm) and shape, with similar density, moisture and energy content.
In our view, based on the foregoing observations, the 2008 Technical Interpretation is not relevant in determining whether the biomass boiler related to the generation of thermal energy, respecting Project #2, could be included in Class 43.2 since the fuel to be consumed in Project #2 to produce thermal energy is not wood pellets.
Project # 2 - Fuel Consumed and the Use of Thermal Energy Generated
In our view, based on the brief description of Project #2 that you have submitted to us, the biomass boiler related to thermal energy generation, involved in Project #2, could not be included in Class 43.2 as it does not fall within subparagraph (d)(ix) of Class 43.1. Our conclusion is based on the following observations.
Two of the preconditions for the application of subparagraph (d)(ix) of Class 43.1 are that the thermal energy is generated through the consumption of Eligible Waste Fuel 2008 [not defined – presumably “eligible waste fuel” as modified by the 2008 Budget] and that the thermal energy (heat) generated is used directly in an industrial process or greenhouse.
In our view, based on the brief description of Project #2 that you have submitted to us, the biomass boiler involved in this project would not come within subparagraph (d)(ix) of Class 43.1 as the thermal energy (heat) produced is not used directly in either an industrial process or a greenhouse.
Furthermore, we are of the view that the biomass boiler involved in Project #2 could not come within subparagraph (d)(ix) of Class 43.1 since, in our view, the thermal energy would not be generated by the consumption of an Eligible Waste Fuel 2008, based on the following observations.
As previously stated, Eligible Waste Fuel 2008 includes wood waste.
Subsection 1104(13) of the Regulations defines "wood waste" (as proposed, on June 10, 2006, by subsection 1(1) of the Regulations amending the Income Tax Regulations (Capital Cost Allowance - Forest Bioenergy Equipment), which is deemed to have come into force on November 14, 2005) as follows:
[W]ood waste includes scrap wood, sawdust, wood chips, bark, limbs, saw-ends and hog fuel, but does not include spent pulping liquor and any waste that no longer has the physical or chemical properties of wood.
By virtue of subsections 13(18.1) and 66.1(6), in determining whether property meets the criteria set out in the Regulations in respect of prescribed energy conservation property, and in determining whether an outlay or expense made or incurred meets the prescribed criteria for CRCE, respectively, the Guide published by NRCan entitled "Class 43.1 - Technical Guide and Technical Guide to Canadian Renewable and Conservation Expenses (CRCE)" (the "NRCan Guide") is conclusive on technical and scientific matters.
In the NRCan Guide, the term "wood waste" is defined on page 36 of Section 1 as follows:
[TaxInterpretations translation] Main wastes and organic residues generated by activities directly associated with the forest industry and the manufacture of wood products, including:
- forest residues such as logging waste, unsaleable trees, salvage and deforestation residues and yard debris;
- sawdust, shavings, trimmings, cuttings and offcuts generated by the manufacture of wood products.
- mill wastes such as sawdust, bark, trimmings and offcuts;
Wood waste does not include paper, sludge, clarifier effluent, black liquor or other residues from the secondary forest industry or any other waste that no longer possesses the physical and chemical properties of wood.
[Emphasis added]
In our view, given the general observations stated above and based on the brief description of Project #2 that you have submitted to us, the chipped trees do not appear to meet the definition of "wood waste" since they are not waste generated by activities directly associated with the forest industry and the manufacture of wood products.
Consequently, the biomass boiler related to thermal energy generation, involved in Project #2, could not be included in either Class 43.1 or 43.2.
Other information
The Class 43.1/43.2 Secretariat (Industrial Innovation Group (IIG), Office of Energy Efficiency (OEE) of NRCan is responsible for providing information to the CRA and others who request it on technical issues related to tax incentives for business investments in renewable energy and energy conservation projects. In this regard, a form for requesting an opinion on the technical eligibility of a property for Class 43.1 or 43.2 treatment is available in the Guide to NRCan, which is available free of charge from:
Class 43.1 and 43.2 Secretariat
CANMET Energy Technology Centre (CETC) – Ottawa
Natural Resources Canada
1 Haanel Drive, Building 3, Room 204
Nepean, Ontario, K1A 1M1
We hope that our comments are of assistance.
Best regards,
Maurice Bisson, CGA
Manager
Corporate Reorganizations and Resource Industry Section
Corporate Reorganizations and Resource Industry Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.
FOOTNOTES
Due to our system requirements, footnotes contained in the original document are reproduced below:
1 http://canmetenergy-canmetenergie.nrcan-rncan.gc.ca/eng/bioenergy/bioco...