As part of Canada’s commitment to reduce overall greenhouse gas emissions, successive federal governments have introduced a number of tax measures to incentivize investment in environmentally-friendly energy alternatives.
With the current Liberal federal government likely seeking to introduce additional measures, potentially as early as the next federal budget, this article discusses some of the more commonly used incentive measures currently in place.
The Income Tax Act (Canada) (the Tax Act) generally prohibits taxpayers from deducting capital expenditures. Instead, taxpayers are entitled to claim a form of tax depreciation, or “capital cost allowance” (CCA), in respect of amounts expended on capital properties which are also “depreciable properties”. Essentially, taxpayers may deduct a percentage of the property’s value in respect of notional depreciation every year in which they own the property, until the property is fully depreciated. The percentage amount of CCA that taxpayers can deduct in a given year is set out in the Income Tax Regulations (the Regulations), and is based on the “Class”, as set out in the Regulations, which that property falls into. Different Classes allow for depreciation to be claimed on a straight line or declining-balance basis. For example, taxpayers are permitted to deduct up to 20% of the cost of a property belonging to Class 8 on a declining-balance basis in a particular year. Here we examine four CCA Classes which are relevant to renewable energy investments: 43.1, 43.2, 54 and 55.
Class 43.1 includes wind turbines, certain fuel cells, photovoltaic solar conversion equipment, waste fuel systems (i.e., landfill gas, manure and wood waste) and high efficiency co-generation systems. Class 43.1 assets are entitled to a 30% declining-balance CCA rate but are also often eligible for inclusion in Class 43.2, provided they meet certain technical metrics, which has a 50% CCA rate. The “specified energy property” rules set out in the Regulations should be considered when contemplating Class 43.1 or 43.2 deductions, as these rules may, subject to various exceptions, limit the CCA claimable in a year to the amount of income earned from Class 43.1 or 43.2 properties in that year, notwithstanding the CCA deduction that would otherwise be available.
The 2019 federal budget introduced 100% CCA Classes (54 and 55), both of which are temporary, for certain zero-emissions automobiles that would otherwise be included in CCA Classes with lower CCA rates. Additionally, taxpayers may deduct up to $55,000 of CCA in respect of Class 54 property, instead of the $30,000 they would otherwise be able to deduct. This high CCA rate will remain in place for vehicles that become available for use in a business between March 19, 2019, until the end of 2023, after which they will be phased out until vehicles that become available for use in 2028, or later, will not be eligible. This budget also introduced GST/HST measures to increase the amount of GST/HST that businesses can recover in respect of zero-emissions passenger vehicles.
Canadian Renewable and Conservation Expenses (CRCE)
Generally, expenses incurred to develop a capital property (including depreciable property) will not be deductible under the Tax Act but will be added to that property’s tax cost (which typically results in a lower capital gain when the property is eventually sold, or, if the property is depreciable property, more CCA once the property becomes available for use or). However, if an expense is incurred to develop depreciable property, and at least 50% of that depreciable property is Class 43.1 or 43.2 property, the costs incurred in the development may be immediately deductible as CRCE. Any amounts in excess of income earned in the year can generally be carried forward and deducted against income in subsequent years.
Certain “principal business corporations” can also issue “flow-through shares” (FTS) instead of deducting CRCE or carrying it forward. FTS allow the corporation to “renounce” CRCE, and let it “flow through” to shareholders, who can then claim the CRCE deduction against their own income. Although this treatment is generally beneficial to investors, and start-up projects looking to attract investment, it is subject to several limitations that need to be reviewed based on each project’s circumstances.