Principal Issues: In a given fact situation, where the taxpayer produces biogas through a digester using a codigestion process (manure and other substances) and where the biogas production is purified into methane in part for sale, whether (1) the digester is property that could be included in class 43.1? and (2) the purification of the biogas into methane for sale is an admissible use of the biogas for the purpose of class 43.1?
Position: (1) No. (2) No.
Reasons: The words of subparagraph (d)(xiii) of class 43.1 of Schedule II of the Income Tax Regulations provide that (1) only property used to produce biogas from manure qualifies for inclusion in this class and (2) the biogas must be used by the taxpayer or a lessee primarily to produce heat or electricity.
XXXXXXXXXX 2006-019004 M. LeBlond November 15, 2006
Dear Sir,
Subject: Class 43.1 on energy saving and alternative energy
As agreed in a telephone conversation on October 16, 2006 (Mr. Bisson/XXXXXXXX) and further to our correspondence of October 2, 2006, this letter is in response to your letter of August 9, 2006, requesting our comments on the application of Class 43.1 of Schedule II of the Income Tax Regulations (the "Regulations") to biogas production equipment, in the situation described below.
Unless otherwise indicated, all statutory references herein are to provisions of the Income Tax Act (the "Act").
The Situation
- XXXXXXXXXX ("Opco") is a business specialized in the utilization of biomass through anaerobic digestion processes in order to produce biogas (a gas composed most significantly of methane) that can be used as a source of energy.
- Currently, Opco has at least XXXXXXXXXX manure and slurry biomethanization projects under consideration, including one for XXXXXXXXXX tons (the "Project").
- The Project will require the installation of a machine, commonly known as a "digester", with a capacity of XXXXXXXXXX tons.
- Opco is of the view that the performance of a "digester" operating exclusively with manure can be improved by using a so-called "co-digestion" process, i.e. a process that provides for the addition of, for example, organic waste to the manure. For example, in the case of the Project, using only pig manure, the total production of the facility would be XXXXXXXXXX Nm3 of biogas or the equivalent of XXXXXXXXXX Nm3 of methane. On the other hand, using the "co-digestion" process, e.g. using a mixture of XXXXXXXXXX% slurry and XXXXXXXXXX% other organic material (slaughterhouse sludge, plant waste, etc.), the output of the plant would be XXXXXXXXXX Nm3 of biogas equivalent to XXXXXXXXXX Nm3 of methane.
- For either of the digestion processes used in the Project, the costs of the installation would be the same, in the order of $XXXXXXXXXX.
- We understand that some of the biogas produced from the Project would be converted into electricity, which would be used by Opco or sold in accordance with applicable provincial legislation, and some would be purified into methane which would be marketed to industrial businesses to produce heat for use in an industrial process or to produce electricity.
- The federal government, in Budget 2005, proposed to extend eligibility for Class 43.1 of Schedule II of the Regulations to biogas production equipment. In Annex 8 - Tax Measures: Supplementary Information and Notice of Ways and Means Motion of the 2005 Budget Plan, tabled in the House of Commons on February 23, 2005, the following budget proposals on this subject are described on pages 446 and 450 [In English version, pages 400 and 403-404:
Efficient and renewable energy generation equipment
An accelerated capital cost allowance (CCA) rate of 30 per cent is provided under Class 43.1 in Schedule II to the Income Tax Regulations for investments in equipment that, in general, produces heat for an industrial process, or electricity, by using fossil fuel efficiently or renewable energy sources. This accelerated rate is an explicit exception to the practice of setting CCA rates to reflect the useful life of assets.
Where the majority of the tangible property acquired for use in a project is included in Class 43.1, certain start-up expenses (mostly intangible) for the project are treated as Canadian Renewable and Conservation Expenses [CRCE]. These expenses may be deducted in full in the year incurred, carried forward indefinitely for use in future years, or transferred to investors under flow-through share agreements.
Biogas production equipment
Class 43.1 currently includes above-ground equipment used primarily to collect landfill gas and digester gas from a licensed sewage treatment facility. Capture and use of these greenhouse gases contributes to climate change objectives, utilizes energy that would otherwise be wasted, and diversifies Canada's energy supply mix.
To encourage further capture and use of biogas, the budget proposes to expand eligibility for Class 43.1 to equipment used to produce biogas (which is primarily methane) from the anaerobic digestion of manure. Eligible equipment will be property of a taxpayer that is part of a system that is used by the taxpayer (or a lessee) primarily to produce, store and use biogas primarily for the production by the taxpayer (or the lessee) of heat for use in an industrial process, or electricity, and that is an anaerobic digester reactor, a buffer tank, biogas piping, a biogas storage tank, a biogas scrubbing equipment, or generation equipment. Collection equipment, buildings and other structures, and equipment used to process the residue after digestion or to treat recovered liquids, will not be included.
This change will apply to eligible equipment acquired on or after February 23, 2005. Further, such eligible equipment acquired before 2012 will be included in the new 50-per-cent CAA rate Class.
[Emphasis added]
- In the fall of 2005, an agent of Opco obtained written confirmation from a Department of Finance representative that the proposed Regulations for the above-mentioned budget proposals include the addition of "digesters" using manure to produce biogas to Class 43.1 (the "Biogas Regulations"). Furthermore, the representative of the Department of Finance indicated to the Opco agent that he expects the Biogas Regulations to be published in the Canada Gazette, Part II (Official Regulations) within weeks of the publication of the proposed Biogas Regulations in the Canada Gazette, Part I (Notices and Proposed Regulations), scheduled for December 10, 2005.
-
Your Questions
Your first question is whether the "digester" used in the Project to produce biogas by the "co-digestion" process could be considered Class 43.1 property in Schedule II of the Regulations.
In that regard, you are of the view that "co-digestion meets the requirements of Class 43.1 because it is still primarily using manure in the process and the addition is only intended to increase the yield. It is not an expansion of Class 43.1 through the back door but rather using a catalyst to increase yield."
Furthermore, you asked us, in the situation that you presented, whether the purification of a portion of the biogas produced in the context of the Project into methane that would be marketed to industrial companies to enable them to produce heat, which they would use in their industrial process, or electricity, is an eligible use of the biogas for the purposes of subparagraph d)(xiii) of Class 43.1 of Schedule II of the proposed Biogas Regulations.
Finally, you wish to know how to request advance rulings on "Canadian renewable and conservation Expenses" ("CRCE").
Our Comments
As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, it is the practice of our Directorate not to issue written opinions on proposed transactions otherwise than by way of advance rulings. Furthermore, when it comes to determining whether a completed transaction has received appropriate tax treatment, that determination is made first by our Tax Services Offices as a result of their review of all facts and documents, which is usually performed as part of an audit engagement. However, we can offer the following general comments which may not apply in full to the situation you have submitted to us.
The Biogas Regulations amending the Capital Cost Allowance Regulations to, inter alia, expand the scope of Class 43.1 of Schedule II to the Regulations to include biogas production equipment, were published on June 1, 2006, in the Canada Gazette, Part II (Official Regulations) Vol. 140, No. 12. Paragraph (d) of Class 43.1 of Schedule II to the Regulations was amended by SOR/2006-117, 12(4) to add subparagraph (d)(xiii), applicable to property acquired after February 22, 2005.
Subparagraph (d)(xiii) of Class 43.1 of Schedule II to the Regulations reads as follows:
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
[…]
(xiii) property of a taxpayer that is part of a system that is used by the taxpayer or a lessee of the taxpayer primarily to produce, store and use biogas produced from manure by anaerobic digestion if that biogas is used primarily by the taxpayer or the lessee to produce electricity, or to produce heat that is used directly in an industrial process or in a greenhouse, which property
(A) includes equipment that is an anaerobic digester reactor, a buffer tank, a pre-treatment tank, biogas piping, a biogas storage tank, biogas scrubbing equipment and electrical generating equipment, and
(B) does not include property that is used to collect manure, store manure (other than a buffer tank) or move manure to the system, equipment used to process the residue after digestion or to treat recovered liquids, auxiliary electrical generating equipment, buildings or other structures, transmission equipment, distribution equipment, equipment designed to store electrical energy, property otherwise included in Class 10 and property that would be included in Class 17 if that class were read without reference to its subparagraph (a.1)(i),
[emphasis added]
The Biogas Regulation also adds a new Class 43.2 to Schedule II of the Regulations. The effect of this addition is to increase the capital cost allowance rate for renewable energy generation equipment, including biogas generation equipment, from 30% to 50%. To qualify for this new increased rate of capital cost allowance under new Class 43.2 of Schedule II to the Regulations, the equipment must generally be new and acquired after February 22, 2005, and before 2012.
Schedule II of the Regulation regarding the addition of Class 43.2 reads as follows:
Property that is acquired after February 22, 2005 and before 2012 (other than property that was included, before it was acquired, in another Class in this Schedule by any taxpayer) and that is property that would otherwise be included in Class 43.1
(a) if the expression “6,000 BTU” in clause (c)(i)(B) of that Class were read as the expression “4,750 BTU”; or
(b) because of paragraph (d) of that Class.
[emphasis added]
Response to Question 1
In our view, a "digester" could not be included in class 43.1 of Schedule II of the Regulation if it is used to produce biogas by the "co-digestion" process. Our conclusion is based on the following observations.
Under paragraph (d)(xiii)(A) of Class 43.1 of Schedule II to the Regulations, "anaerobic digester reactor" is expressly included in Class 43.1 of Schedule II. Furthermore, according to the preamble to subparagraph (d)(xiii), in order for a taxpayer's "anaerobic digester reactor" to be included in Class 43.1 of Schedule II, it must, inter alia, be used primarily "to produce, ... biogas produced from manure by anaerobic digestion".
In the situation you have submitted to us, it appears to us that the "digester" could not be included in Class 43.1 of Schedule II if the biogas production from the digester does not originate exclusively from the anaerobic digestion of manure.
Response to Question 2
In our view, the purification of biogas into methane for sale is not an eligible use of biogas for the purpose of determining whether property that is part of a taxpayer's biogas production system is eligible for inclusion in Class 43.1 of Schedule II to the Regulations.
Not all of the conditions that must be satisfied for a property to be included in Class 43.1 of Schedule II to the Regulations are described in subparagraph (d)(xiii) of Class 43.1 of Schedule II to the Regulations. Indeed, other conditions in that regard are set out in paragraph (e) of Class 43.1 of Schedule II to the Regulations, which reads as follows
(e) that
(i) is situated in Canada,
(ii) is
(A) acquired by the taxpayer for use by the taxpayer for the purpose of gaining or producing income from a business carried on in Canada or from property situated in Canada, or
(B) leased by the taxpayer to a lessee for the use by the lessee for the purpose of gaining or producing income from a business carried on in Canada or from property situated in Canada, and
(iii) has not been used for any purpose before it was acquired by the taxpayer unless
(A) the property was depreciable property that
(I) was included in Class 34, 43.1 or 43.2 of the person from whom it was acquired, or
(II) would have been included in Class 34, 43.1 or 43.2 of the person from whom it was acquired had the person made a valid election to include the property in Class 43.1 or 43.2, as the case may be, under paragraph 1102(8)(d) or 1102(9)(d), and
(B) the property was acquired by the taxpayer not more than five years after the time it is considered to have become available for use, for the purpose of subsection 13(26) of the Act, by the person from whom it was acquired and remains at the same site in Canada as that at which that person used the property.
It follows from subparagraphs (d)(xiii) and (e)(ii) of Class 43. 1 of Schedule II to the Regulations, that for the property of a taxpayer's system to be included in that Class, (1) the taxpayer, as owner of the system, or the person to whom the taxpayer leases the system (the lessee of the taxpayer), must use the property primarily to produce, store or use biogas, (2) the biogas must be used primarily by the taxpayer or the lessee of the taxpayer to produce either heat, which must be used directly in an industrial process or a greenhouse, or electricity, and (3) the taxpayer must acquire or the lessee of the taxpayer must use the property that is part of the taxpayer's system for the purpose of gaining or producing income from a business carried on in Canada or from a property situated in Canada
In the situation you have presented, some of the biogas produced from the Project would be purified into methane that would be marketed to industrial corporations to enable them to produce heat for use in an industrial process or to produce electricity. In our view, the sale of methane is not in itself an eligible use of biogas for the purpose of determining whether property that is part of a biogas production system can be included in Class 43.1 of Schedule II to the Regulations. However, the fact that some of the biogas production, once purified to methane, is sold by Opco would not, in and of itself, preclude property that is part of Opco's biogas production system from being included in Class 43. 1 of Schedule II to the Regulations, if the biogas produced by Opco's system as part of the Project was used primarily (i.e., more than 50 percent) by Opco to produce either heat, which would be used directly by the user in an industrial process or greenhouse, or electricity (the "Eligible Uses") and the other conditions set out in paragraphs (d) and (e) of Class 43.1 of Schedule II to the Regulations were satisfied. In other words, the sale by Opco of methane from the biogas produced by the Project, in and of itself, would not prevent the property that is part of Opco's biogas production system from being included in Class 43.1 of Schedule II of the Regulations provided that less than 50 percent of the biogas produced by the Project is converted into methane for sale and more than 50 percent of the biogas produced by the Project is used for Eligible Uses.
Response to Question 3
With respect to the question of how to request advance income tax rulings on CRCE, there are no specific requirements for a CRCE advance ruling request. See paragraph 16 of Information Circular 70-6R5 - Advance Income Tax Rulings, for a description of the information required to request an advance income tax ruling. Other relevant information about requesting an advance income tax ruling can also be found in that circular. Information Circular 70-6R5 is available on the Canada Revenue Agency website at http://www.cra-arc.gc.ca/E/pub/tp/ic70-6r5/
We hope that these comments are of assistance.
Best regards,
Maurice Bisson, CGA
Manager
Corporate Reorganizations and Resource Industries Section
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch