A monthly feature focusing on current Tax Topics, written by Jack Berstein and Barb Worndl, Aird & Berlis LLP.
The demand for solar power (clean energy) coupled with attractive tax incentives and the ability to sell the electricity have made solar power syndications popular.
Generally the owner of the solar power panels will lease or license the rooftop of buildings and then sell the resulting electricity.
A limited partnership (LP) is the traditional vehicle of choice. The investors will become limited partners. The developer will arrange for the design, construction, financing, and installation and then assign or sell its rights to the LP. The developer will be the initial limited partner and will get a fee for pulling the project together.
The developer may also own the general partner and use a separate entity to provide maintenance and management services for a fee to the LP.
The LP will own the project, purchase the equipment, lease or license the rooftop space from the landlords, and carry on the business of producing electricity for sale. A landlord may prefer a licence as it is less likely to impact mortgage covenants. The LP will purchase the equipment and benefit from the accelerated depreciation. Solar panels are Class 43.2 assets, available for the 50% capital cost allowance (CCA) rate subject to the half-year rule (i.e., CCA is claimed over three years). It is not possible to deduct a loss from CCA from specified energy property unless the owner or all partners are principal business corporations (discussed below).
Various expenses incurred in the pre-production development phase of the solar project may be eligible for Canadian renewable conservation expense (CRCE) treatment. A condition is that it be reasonable to expect that at least 50% of the capital cost of depreciable property to be used in the project would qualify as Class 43.1 or 43.2 assets. Expenses that qualify as CRCE can be deducted in the year they are incurred or carried forward. CRCE incurred by a partnership will be allocated to its partners at the end of the partnership fiscal year period. Limited partners may deduct losses up to their at risk amount (generally capital invested plus income allocated less income and capital distributions and any amounts which are guaranteed).
Eligible expenses may include:
- costs necessary to determine the extent of the resource (including temporary roads);
- negotiation costs that don’t relate to property or financing;
- site approval costs;
- evaluation, environmental, and other feasibility studies that are site-specific; and market research to establish energy demand.
Eligible expenses do not include:
- the cost of most depreciable property such as solar panels;
- interest and financing costs;
- cost of land and the right to use land (lease payments);
- administration and management expenses;
- amounts payable to a non-resident person or non-Canadian partnership;
- eligible capital expenditures; and
- any expenditure made after the earliest time at which (Class 43.1 or 43.2) property was used in the project to generate income.
A corporation is a principal business corporation for purposes of claiming a loss from CCA on specified energy property, where the principal business of the corporation throughout the year is:
- manufacturing or processing;
- mining operations; or
- the sale, distribution, or production of electricity, natural gas, oil, steam, heat, or any form of energy or potential energy.
For a partnership, if any partner is not a principal business corporation, then none of the partners will have access to losses that could have been generated by accelerated depreciation.
Interest expense incurred by the LP on a loan for the business should be deductible as well as management fees and other operating expenses.
An alternative to an LP is to have a corporation carry on the business. A corporation may incur CRCE and renounce those expenses in favour of its shareholders who may claim the deductions. The shares subject to the renunciation are called flow-through shares. The corporation issuing the shares must be a principal business corporation. The definition of principal business corporation for this purpose is not the same as discussed above; very generally, it includes oil and gas corporations, mining corporations, and corporations that have, as their principal business, the generation of energy or the production of fuel using assets included in Class 43.1 or 43.2 and/or the development of projects where it is reasonable to expect that at least 50% of the capital cost of the depreciable property would be property described in Class 43.1 or 43.2. It issues a flow-through common share from the treasury in exchange for consideration and agrees to renounce CRCE to the shareholder. In some circumstances, the company can renounce CRCE before it is actually incurred. Shareholders may deduct all CRCE renounced to them in the year against other income.
One should consider whether the investment must be registered as a tax shelter. If an investment is a tax shelter and not registered, then investors are denied all deductions and the promoter is liable. The registration requirement is directed at marketed investments and enables the Canada Revenue Agency (CRA) to identify promoters and investors of tax shelters and to detect trends in tax shelter promotions. The tax shelter investment rules limit the deductions and credits available to ‘‘tax shelter investments’’. It applies to cases outside the at-risk rules, which limit the deductions of limited partners, share investors, or others protected from realizing economic loss. Tax shelter status is based on certain statements or representations made or proposed to be made to prospective investors.
The investment will be a tax shelter if statements or representations were made that within four years after its acquisition, the aggregate amount of tax deductions or other tax benefits represented to be available regarding the investment was equal to or greater than the cost of the investment less certain prescribed benefits or financial assistance received to acquire the investment. The promoter of the tax shelter must apply in prescribed form for an identification number. No amount may be claimed or deducted by an investor regarding an interest in a tax shelter unless an ID number provided by the CRA is mentioned on the return. The penalty for failing to obtain an ID number before selling investments in a tax shelter is 25% of the amount raised.
An investment in flow-through shares is not a tax shelter. There are special considerations when there are non-resident investors. If a non-resident is a limited partner, then they are deemed to carry on business in Canada. The non-resident must file a Canadian tax return and pay tax under Part I. A non-resident corporation will be liable for Canadian corporate tax and branch tax. There is no Canadian withholding tax on amounts paid by a distribution company to an LP, having non-resident limited partners, for the electricity generated. If the non-residents have loaned funds to the partnership at interest, there will not be any Canadian withholding tax on the interest if the loan is arm’s length. If the loan is non-arm’s length, then the rate of Canadian withholding tax will be 25% of the amount raised.
If a corporation is the investment vehicle, then the thin capitalization rules would deny the deduction of interest in excess of a 2:1 debt-to-equity ratio for interest paid to a non-resident shareholder owning 25% or more of the shares.
This article appeared in the August 2011 issue of CCH’s newsletter Tax Profile, No. 8.
EXPLANATORY NOTES RELEASED FOR DRAFT LEGISLATION ON 2011 BUDGET MEASURES
On September 1, 2011, the Department of Finance released the Explanatory Notes for the draft legislation released on August 16, 2011 to implement the 2011 Budget proposals. Subscribers to the Canadian Tax Reporter (print, DVD, or online) will receive a copy of CCH Special Report 059H, which contains the draft legislation and regulations and Explanatory Notes for the 2011 Budget proposals. Additional copies of the Special Report may be ordered by calling
(416) 224-2248 (toll-free 1-800-268-4522), by faxing (416) 224-2243 (toll-free 1-800-461-4131), or by e-mailing email@example.com. The draft legislation has been added to the Income Tax Act and Regulations on CCH online and the Explanatory Notes will be added as soon as possible.