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By: Tom Routley

For a number of years now the federal government has provided tax incentives for the production of clean energy. These incentives are primarily in the form of accelerated tax depreciation (50% per year on a declining balance basis) and have been provided for in the form of Class 43.1 and more recently Class 43.2. The incentive is the economic advantage of deferring cash tax payments through the exemption from the conventional tax depreciation rules based on the useful life of the asset.

In this article I will review the 2010 Budget’s enhancements to these tax incentives.

As a reminder, Class 43.2 includes equipment that conserves or generates energy through:

• The use of a renewable energy source (e.g. wind, solar);
• The use of waste fuels (e.g. wood waste, landfill gas); and
• The more efficient use of fossil fuels (e.g. high efficiency cogeneration systems producing both electricity and heat).

As is the case with most tax legislation, there are a number of restrictions on the access to these accelerated tax depreciation deductions driven by policy dictates. The following is an example of a restriction subject to expansion in the 2010 Budget:

Prior to this Budget, heat recovery equipment has only been eligible for Class 43.2 if the heat recovered from electrical or cogeneration equipment is reused by the same equipment to generate electricity or, in the case of heat generated directly in an industrial process, reused directly in an industrial process.

Heat Recovery Equipment

The 2010 Budget will expand access to this Class 43.2 for new equipment acquired on or after March 4th, 2010. The primary expansion is to eliminate the restriction on heat recovery equipment to only those situations where the recovered heat was reused in a process of the same type that generated it. The following example was provided in the 2010 Budget to clarify this new expansion rule:

Qualifying equipment will now include equipment that used to capture waste heat generated by a boiler in an industrial process for use in heating the plant – and even nearby buildings.

However, as usual, there are still some small technical limitations on access to this new type of qualifying equipment.

District Energy System Distribution Equipment

There is one other expansion of access to Classes 43.1 and 43.2, and that is for distribution equipment used in a “district energy system”. In general terms, a district energy system is viewed as consisting of a central generation plant and a group of surrounding buildings that circulate steam, hot or cold water though underground pipes. For district energy system distribution equipment to qualify for Classes 43.1 and 43.2, the equipment has to be distributing heat produced by electrical cogeneration equipment. More recently, space-heating technologies such as active solar and ground-source heat pumps also qualify for these Classes.

The 2010 Budget provision related to district energy system new equipment acquired on or after March 4th, 2010, will broaden Classes 43.1 and 43.2 to include the distribution equipment that is used to provide heating or cooling through the use of thermal energy provided primarily by an active solar system, ground source heat pump system, heat recovery equipment or any combination of these, provided the generation equipment itself qualified for these Classes.

Policy Thinking

It is important to note the fiscal policy thinking behind both provisions. The tax break for Heat Recovery Equipment is viewed as incenting the use of this equipment to displace the use of fossil fuel driven energy sources. The District Energy System Distribution Equipment incentive is viewed as increasing the economic viability of such systems through efficiencies of scale. It also reflects some effective lobbying.

Final Thoughts

Given the progression of more generous rules regarding the delivery of federal tax incentives for clean energy (i.e. in particular the continued peel-back-the-onion approach to restrictions on access to them), it would appear that the federal government is committed to encouraging the private marketplace to invest in this sector.

It seems to me we will shortly have to stop referring to these tax incentives as “greenwash tax breaks”. Like other cases of greenwash, these federal tax incentives for clean energy looked good on paper, but dissolved on closer inspection. Sounds-good policy, but through the impact of the many technical restrictions and, more importantly, the lack of tax-paying corporations (there is no economic benefit to be gained for an accelerated tax deduction on a tax return drowning in losses), these efforts have not generated the results intended by the policy wonks. But with the improvements in the Canadian economy and the federal onion peels all over the floor, we may finally be getting somewhere.

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Tom Routley is a chartered accountant with over 30 years of experience in both the Canadian and United States income tax rules related to energy tax incentives, tax-efficient financing and R&D tax incentives.