Written By Greg Johnson, Jason Roth, Ashley White, Michael Smith, Marshall Eidinger and Brendan Sigalet
The Government of Canada continued their drive to decarbonize the economy through the use of the carrot rather than the stick in Budget 2023 by announcing two new investment tax credits:
- a Clean Electricity Investment Tax Credit (Clean Electricity ITC); and
- a Clean Technology Manufacturing Tax Credit (Clean Manufacturing ITC).
Additionally, as promised by the Government of Canada in their 2022 Fall Economic Statement, Budget 2023 provided further details with respect to the Clean Hydrogen Investment Tax Credit (Clean Hydrogen ITC).
These incentives are intended to further incentivize the adoption of clean energy technology to assist in Canada's goal of a net-zero economy by 2050 as outlined in the federal government's 2030 Emissions Reduction Plan, and are in keeping with previous tax policy, such as the Carbon Capture, Utilization and Storage Tax Credit (the CCUS Tax Credit) that was established by Budget 2022, and the Clean Technology Investment Tax Credit (Clean Tech ITC) announced in the 2022 Fall Economic Statement (2022 FES).
Clean Electricity ITC
The Budget 2023 proposes a 15 percent refundable tax credit for eligible investments in Clean Electricity, including:
- non-emitting electricity generation systems, including: wind, concentrated solar, solar photovoltaic, hydro (including large-scale), wave, tidal and nuclear (including large scale and small modular nuclear reactors);
- abated natural gas-fired electricity generation (subject to an emissions intensity threshold compatible with a net-zero grid by 2035);
- stationary electricity storage systems that do not use fossil fuels in operation, such as batteries, pumped hydroelectric storage and compressed air storage; and
- equipment for transmission of electricity between provinces and territories.
The Budget states that both new and the refurbishment of existing facilities will be eligible. Interestingly, the Budget also states that both taxable and non-taxable entities (which would include Crown corporations, publicly owned utilities, corporations owned by indigenous communities and pension funds) will be eligible for the Clean Electricity ITC. This is a significant change from other investment tax credits which are generally not available to tax exempt entities.
The Clean Electricity ITC is proposed to be available for Clean Electricity projects as of the day the 2024 Budget is released, so long as the project did not begin construction as of March 28, 2023 (Budget Day).
An additional requirement of the Clean Electricity ITC is that a "competent authority" within each province and territory must make a commitment to the Government of Canada that the federal funding will be used to lower electricity bills within the jurisdiction, and to commit to a net-zero electricity sector by 2035.
The Department of Finance will consult with provinces, territories and other relevant parties on the design and implementation details of the Clean Electricity ITC.
Clean Manufacturing ITC
Budget 2023 further proposes a 30 percent refundable tax credit for investments in new machinery and equipment used in eligible activities, generally aimed at manufacturing or processing of equipment and property used in certain clean technologies, or extracting, processing, or recycling key critical minerals. The eligible activities include:
- manufacturing of certain renewable energy equipment (solar, wind, water or geothermal) and nuclear energy equipment;
- manufacturing of nuclear fuel rods, as well as processing or recycling of nuclear fuels and heavy water;
- manufacturing of electrical energy storage equipment used to provide grid-scale storage or other ancillary services;
- manufacturing of equipment for air and ground-source heat pump systems;
- manufacturing of zero-emission vehicles (including conversion of on-road vehicles), as well as manufacturing of batteries, fuel cells, recharging systems and hydrogen refueling stations for zero-emission vehicles;
- manufacturing of equipment used to produce hydrogen from water electrolysis;
- manufacturing or processing of upstream components, sub-assemblies, and materials provided that the output would be purpose built or designed exclusively to be integral to other eligible clean technology manufacturing (specifically mentioned are cathode materials and batteries used in electric vehicles); and
- extraction, processing or recycling of critical minerals essential for the clean technology supply chains, specifically: lithium, cobalt, nickel, graphite, copper and rare earth minerals.
This incentive appears aimed at increasing domestic manufacturing of components required for clean technology.
With respect to the critical mineral component of the credit, this appears to complement the Critical Mineral Exploration Tax Credit that was announced in Budget 2022, which incentivizes the exploration for critical minerals. Finance appears to have zeroed in on a subset of the critical minerals as defined in that proposed legislation in the six minerals listed above, to further incentivize their production by providing an additional tax credit for their extraction and processing.
The Clean Manufacturing ITC will be available for property that is acquired and becomes available for use on or after January 1, 2024. The Clean Manufacturing ITC will be phased out beginning in 2032, with property that becomes available for use in 2032 qualifying for a 20 percent tax credit, property available for use in 2033 qualifying for a 10 percent tax credit, and property available for use in 2034 qualifying for a 5 percent tax credit. The Clean Manufacturing ITC will no longer be available for property available for use after 2034.
Clean Hydrogen ITC
Budget 2023 has also provided further details with respect to the proposed Clean Hydrogen ITC that was announced in the 2022 FES. The Clean Hydrogen ITC will be available in respect of the cost of purchasing and installing equipment for projects that produce all, or substantially all hydrogen from their production processes, not taking into account any CO2 produced, or any excess electricity that is sold to the grid. Initially, eligibility for the Clean Hydrogen ITC will be restricted to projects that produce hydrogen from either water electrolysis, or through natural gas so long as emissions are abated using carbon capture. The Government of Canada will continue to review eligibility for other hydrogen production pathways.
The Clean Hydrogen ITC will be available for property that is acquired and becomes available for use on or after Budget Day.
As expected, the Clean Hydrogen ITC will provide a tiered refundable tax credit, with projects that produce the cleanest hydrogen receiving a higher tax credit. The tiers are as follows:
|Carbon Intensity Tiers||Tax Credit Rate|
|0.75 kg to <2.0 kg||25%|
|2.0 kg to <4kg||15%|
The carbon intensity tiers reflect the expected life-cycle emissions of a project based on its carbon intensity, measured as the kilograms of CO2 produced per kilogram of hydrogen manufactured. For reference, the most common form of hydrogen production produced with natural gas through steam methane reforming creates around 10 to 12 kg of CO2 per kg of hydrogen. This hydrogen is colloquially known as "grey hydrogen."
The addition of carbon capture to this process serves to create what is colloquially known as "blue hydrogen," which can reduce the carbon intensity to between 1.5 and 5 kg of CO2 per kg hydrogen, and therefore may qualify for the Clean Hydrogen ITC. The cleanest hydrogen, commonly known as "green hydrogen" is produced through a process known as water electrolysis, and produces no carbon emissions, and therefore would be eligible for the Clean Hydrogen ITC at the 40 percent tax credit rate.
With respect to measuring of the carbon intensity, any captured carbon needs to be stored via an "eligible use" as defined in the proposed legislation for the CCUS Tax Credit, otherwise it is considered to be released into the atmosphere for the purpose of the Clean Hydrogen ITC.
Comparison to the Inflation Reduction Act
It is notable that these incentives appear to outpace those provided by the Inflation Reduction Act (IRA) in the United States, which was passed in August 2022 and also offered a tiered tax credit for clean hydrogen production (which was mentioned in the 2022 FES that announced the Clean Hydrogen ITC). For reference; the IRA provides the following tax credit rates:
|Carbon Intensity Tiers||Tax Credit Rate|
|0.45 kg to <1.5 kg||10%|
|1.5 kg to <2.5kg||7.5%|
|2.5 kg to 4 kg||6%|
Budget 2023 describes equipment eligible for the Clean Hydrogen ITC as including any equipment required to produce hydrogen from electrolysis, so long as all or substantially all of the use of the equipment is to produce hydrogen. This includes electrolysers, rectifiers, other ancillary electrical equipment, water treatment and conditioning equipment and hydrogen compression and on site storage equipment.
With respect to abated natural gas processes, any equipment required to produce hydrogen from natural gas is included, excluding equipment described in CCA Classes 57 and 58 (equipment eligible for the CCUS Tax Credit). Eligible equipment includes equipment used all or substantially all for the purpose of producing hydrogen through natural gas reformation. This equipment includes auto thermal reformers, steam methane reformers, pre-heating equipment, shift reactors, purifiers, water treatment and conditioning equipment, and hydrogen compression and on site storage equipment.
Power or heat production equipment that is dual use is eligible so long as more than 50 percent of its use will be in support of either a CCUS process (as defined in the CCUS Tax Credit) or hydrogen production that is eligible for the Clean Hydrogen ITC.
Oxygen production equipment used for hydrogen production will be eligible, so long as it is accompanied by a CCUS process to capture any resulting CO2. Further, equipment that produces heat and or power from natural gas or hydrogen will also be eligible.
Pre-development costs for a Clean Hydrogen project (i.e., feasibility studies, engineering and design studies) are not eligible for the Clean Hydrogen ITC.
Property that is required to convert clean hydrogen into clean ammonia will also be eligible for the Clean Hydrogen ITC, at a rate of 15 percent. The Department of Finance will provide a description of eligible clean ammonia equipment, as well as specific conditions that will apply, at a later date.
Verification & Compliance
Similar to CCUS Tax Credit projects, Clean Hydrogen projects will be required to complete a front end engineering design study in order to apply for the Clean Hydrogen ITC. The project will undergo an initial carbon intensity assessment (CI Assessment), which will assess the initial expected carbon intensity of the project, and the applicable tax credit rate based on two criteria:
- the modelling of the project using the Fuel LCA Model; and
- that the project design can reasonably be expected to achieve the modeled outcome.
Where a project is redesigned, it will need to go through a new CI Assessment.
Once the project is operational, the taxpayer will need to demonstrate and obtain independent third party verification that the carbon intensity of the hydrogen falls into the same tier as expected under the CI Assessment. If the project fails to meet the carbon intensity tier determined in the initial CI Assessment, there will be a clawback of the Clean Hydrogen ITC based on the difference between the tier assessed in the initial CI Assessment and the tier in which the project would fall based on the demonstrated carbon intensity of the project.
The Clean Tech ITC, Clean Hydrogen ITC, and Clean Electricity ITC are proposed to be subject to labour conditions which will have to be adhered to by project proponents in order to be eligible for the full tax credit. For those proponents that do not adhere to these labour conditions, the respective tax credit will be reduced by 10 percent.
The 2022 FES provided that these labour conditions will include paying prevailing wages based on local labour market conditions, and ensuring that apprenticeship training opportunities are being created.
Budget 2023 provides further guidance on these conditions, noting that the labour conditions will only apply to workers whose duties are primarily manual or physical (i.e. labourers and tradespeople), and would not apply to workers whose duties are administrative, clerical, supervisory or executive.
The prevailing wage requirement will require that workers are paid at a level that meets or exceeds a wage specified in an "eligible collective agreement", including any benefits and pension contributions, and can be met through a combination of wages, benefits and pension contributions. An eligible collective agreement will include the most recent collective bargaining agreement between a trade union and group of employers that may reasonably be considered the industry standard for the trade in the particular region.
Alternatively a separate project labour agreement covering the work eligible for the investment tax credit would also qualify, provided that it is based on the industry standard multi-employer collective bargaining agreement described above.
The apprenticeship requirement will be met where not less than 10 percent of the total labour hours performed by covered workers (defined as those whose duties correspond to those performed by a journeyperson in a Red Seal trade) in a given taxation year in the project is carried out by registered apprentices.
These conditions will apply to work performed on or after October 1, 2023.
Overlap of Credits
There is significant overlap between the Clean Electricity ITC, the Clean Tech ITC, the Clean Hydrogen ITC, the Clean Manufacturing ITC, and the CCUS Tax Credit. For example, the Clean Tech ITC also includes solar photovoltaic, small nuclear reactors, wind and water electricity generation systems, as well as batteries and other stationary electricity storage systems. Budget 2023 clarifies that only one ITC can be claimed with respect to any particular property, however it also notes that different ITCs can be claimed on different expenditures within the same project.
For example, a Clean Hydrogen project for the production of blue hydrogen contains property that may be covered by the Clean Hydrogen ITC, as well as other property covered by the CCUS Tax Credit. Budget 2023 confirms that the Clean Hydrogen ITC may be claimed with respect to the Clean Hydrogen ITC eligible equipment, while the CCUS Tax Credit may be claimed with respect to the CCUS Tax Credit eligible equipment.
Many details remain outstanding, particularly for the Clean Electricity ITC, and draft legislation implementing these proposals has not been released. The Clean Hydrogen ITC and the Clean Electricity ITC represent significant opportunities for electricity and hydrogen producers, and can potentially have an impact across a wide range of industries. Further, the Clean Manufacturing ITC represents a significant opportunity for manufacturers to assist in providing the equipment necessary for a new decarbonized economy. The hope is that this begins to level the playing field with the IRA in the United States and creates significant incentives for strong investment in these industries within Canada.
Bennett Jones has experience in energy, infrastructure, mining and manufacturing project development including in power, renewables, clean technology (including EV and stationary storage batteries) and hydrogen and developing strategies for industries to capitalize on current and upcoming initiatives of a low-carbon economy.
To discuss the potential opportunities and implications of the Clean Hydrogen ITC, Clean Manufacturing ITC, or Clean Electricity ITC in Budget 2023, please contact any member of the Bennett Jones Tax or Energy practice groups.