10 February 2005 External T.I. 2005-0113771E5 - CRCE and FTS

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: general information on CRCE and flow-through shares (FTS)

Position: Outlined general requirements of Reg. 1219 (CRCE), deduction available for CRCE (66.1(6)(g.1)) and FTS defined in 66(15).

Reasons: as per legislation

2005-011377
XXXXXXXXXX Catherine Bowen
(613) 957-8284
February 10, 2005

Dear XXXXXXXXXX:

Re: Canadian renewable and conservation expense ("CRCE")

This is in response to your letter of January 24, 2005 wherein you requested our comments on whether a deduction for CRCE is available for a particular mutual fund trust, as well as general information on CRCE.

Our Comments

Although we cannot provide any comments on the CRCE deduction available for a particular mutual fund trust, we can provide the following general comments on CRCE that may be of assistance.

A) CRCE

Certain expenses incurred in the pre-production development phase of renewable energy and energy conservation projects, where it is reasonable to expect that at least 50% of the capital cost of the depreciable property to be used in the project would qualify for inclusion in Class 43.1, will meet the definition of "Canadian renewable and conservation expense" if, among other things, they are payable to a person or partnership with whom the taxpayer is dealing at arm's length.

Examples of the types of expenses that are eligible for CRCE include:

? the cost of pre-feasibility and feasibility studies of suitable sites;
? costs related to determining the extent, location and quality of energy resources;
? negotiation and site approval costs;
? the cost of constructing a temporary access road to the project site; and
? site preparation costs that are not directly related to the installation of equipment.

Examples of the types of expenses that are not eligible for CRCE include:

? amounts that would otherwise be included in the capital cost of depreciable property including all costs directly associated with the acquisition and installation of the property, except those that are listed above as qualifying as CRCE;
? financing and interest charges; and
? administration and management expenses.

As indicated above, one of the requirements to be met in order for an expense related to a project to qualify as CRCE is that it is reasonable to expect that at least 50% of the capital cost of the depreciable property to be used in the project would qualify for inclusion in Class 43.1. Property in that class includes certain electricity generation systems such as cogeneration and specified-waste fuelled electrical generation systems, small-scale hydro-electric installations, and enhanced combined cycle systems.

The determination of whether a particular expense incurred by a taxpayer will qualify as CRCE must be made based upon a review of all of the facts relevant to a particular situation. However, where expenses of a taxpayer do qualify as CRCE, they are added to the taxpayer's Canadian exploration expense ("CEE") (as per paragraph (g.1) of the definition of "Canadian exploration expense" in subsection 66.1(6) of the Income Tax Act). They can then be deducted from the taxpayer's income entirely in the year they are incurred or carried forward indefinitely and deducted in later years.

B) Flow-through shares

It is possible for taxpayers to be able to claim a deduction from their income for CRCE through what are called flow-through shares ("FTS"). Taxpayers can purchase FTS directly from a principal business corporation or invest indirectly in FTS by purchasing units of a partnership that has bought FTS. A principal business corporation includes one that has as its principal business

? the generation of energy using property that is included in Class 43.1, or

? the development of projects for which it is reasonable to expect that at least 50% of the capital cost of depreciable property to be used in each project will be property described in Class 43.1.

In brief, the rules for FTS require that there must be a written agreement between the investors and the corporation outlining certain terms under which the FTS are to be issued. The shares issued are generally new common shares. The corporation can then renounce and flow-through to the investors eligible exploration and development expenses that it incurred on or after the date the agreement was made. Those expenses are deemed, on the effective date of renunciation, to be incurred by the investors to whom

they are renounced, and never to have been incurred by the corporation. Where CEE (including CRCE) is renounced to investors in a year, it is treated as CEE to the investor. Only original investors can deduct the amount of CEE renounced to them from their income. This deduction can be claimed either entirely in the year it is renounced or carried forward indefinitely and deducted in later years. Where FTS are owned by a partnership, such expenses will first be renounced to the partnership, and then the partnership will allocate the renounced expenses among the partners by issuing a Form 5013, Statement of Partnership Income. The cost of a FTS to the person to whom it is issued is deemed to be nil.

Our comments are provided in accordance with the practice outlined in paragraph 22 of Information Circular IC 70-6R5, Advance Income Tax Rulings. We trust our comments are of assistance.

Yours truly,

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Planning Branch