Part 2: CCUS Investment Tax Credit
As noted in Part 1 of this blog post, available here, the release of the federal government’s 2022 budget (the “2022 Budget”) highlights the tension between commitments to a net-zero economy and the enduring importance of fossil fuels in Canada. The government’s 2030 Emissions Reduction Plan, published pursuant to the Canadian Net-Zero Emissions Accountability Act (which enshrines Canada’s commitment to achieve net-zero greenhouse gas emissions by 2050 in law), noted that competing in a future that will see “continued oil and gas use globally, but with demand declining significantly in the coming decades” will require that Canada “offer lower carbon oil and gas to the world.”
In other words, while the commitment to net-zero by 2050 remains, the path to net-zero in Canada promises to follow a gradual transition from fossil fuels, partly supported by investment in technology. In that context, the 2030 Emissions Reduction Plan pledged a carbon capture, utilization and storage strategy. The 2022 Budget delivers on that pledge by introducing a refundable investment tax credit available for businesses that incur eligible expenses in respect of eligible CCUS projects starting as early as January 1, 2022 (the “CCUS Credit”).
While CCUS technologies are an important tool for reducing emissions in high emitting sectors where other options to reduce emissions are limited or unavailable, investing in CCUS technologies is costly. This is where the CCUS Credit comes in. The CCUS Credit would help reduce the upfront capital costs associated with constructing CCUS projects to help reduce emissions in industries such as oil and gas, chemical production and electricity generation.
CCUS Credit Eligibility Criteria
The refundable CCUS Credit will only be available to businesses that incur “eligible expenses” in connection with “eligible CCUS projects” that permanently store captured CO2 via an “eligible use”. Each requirement is discussed briefly below.
Eligible expenses comprise the cost of purchasing and installing “eligible equipment.” Eligible equipment includes only equipment that would be used solely to capture, transport, store, or use CO2 as part of an eligible CCUS project. Expenses that may be related to a CCUS project but are not incurred to acquire “eligible equipment” would not be eligible for the CCUS Credit. For example, it is unlikely that feasibility studies, front end engineering design studies, exploration and development expenses or operating expenses would be considered “eligible expenses.” However, to the extent these expenses are capital in nature, they could be eligible for accelerated capital cost allowance (“CCA”) deductions. For example, the 2022 Budget materials indicate that newly created capital cost allowance classes would allow exploration costs to be depreciated at 100% per year.
A further benefit available to investors in CCUS technologies is that the CCUS Credit could be claimed on eligible expenses in the year in which the expenses are incurred, regardless of whether the eligible equipment is available for use that year. This is a departure from the general rule under the Income Tax Act (Canada) that requires assets to be available for use before a tax deduction (i.e., CCA) can be claimed.
It is important to note that the CCUS Credit will only be available once in respect of any item of equipment. Investors looking to acquire second-hand equipment to be used in an eligible CCUS project will need to undertake proper due diligence to determine whether the vendor has already claimed the CCUS Credit.
Eligible CCUS Projects
An “eligible CCUS project” is any new project that:
- captures CO2 that would otherwise be released into the atmosphere; or
- captures CO2 from the ambient air, prepares the captured CO2 for compression, compresses and transports the captured CO2, and stores or uses the captured CO2.
While CO2 must be captured in Canada in order for investors to access the CCUS Credit, it can be stored or used outside of Canada provided the requirements discussed below under “Eligible Uses” are met and the storage requirements set out by Environment and Climate Change Canada are complied with (e.g., for geological storage, initially the CCUS Credit will only be available for projects that store CO2 in Saskatchewan or Alberta).
CCUS projects will not be considered eligible where emissions reductions are necessary in order for the project to comply with the Reduction of Carbon Dioxide Emissions from Coal-fired Generation of Electricity Regulations or the Regulations Limiting Carbon Dioxide Emissions from Natural Gas-fired Generation of Electricity.
The extent to which the CCUS Credit is available for eligible equipment depends on the end use of the CO2 being captured. In particular, eligible uses only include dedicated geological storage of CO2 and storage of CO2 in concrete. Therefore, “eligible uses” is a bit of a misnomer, as the CCUS Credit does not appear to be available to investors that “use” CO2 as an input in their processes; rather, it is only available to investors that permanently store CO2 as part of their CCUS project. The 2022 Budget materials specify that enhanced oil recovery is not currently considered an eligible use. Where eligible equipment is acquired as part of a project that stores CO2 through both eligible and ineligible uses, the CCUS Credit will still be available; however, it will be prorated to account for the portion of CO2 expected to go to ineligible uses over the life of the project.
Investors will be required to calculate the breakdown of expected eligible versus ineligible uses of CO2 when submitting initial project plans to apply for the CCUS Credit. Once an eligible project begins operating, investors will be required to track and account for the amount of CO2 being captured, and the portions that actually end up going to eligible versus ineligible uses. To the extent that the actual portion of CO2 going to an ineligible use exceeds what was budgeted, investors may be required to repay CCUS Credits that were previously claimed.
Further, in order to claim the CCUS Credit, investors will be required to produce climate-related financial disclosure reports and have their eligible expenses verified by Natural Resources Canada. Verification is expected to occur as soon as possible after the end of the investor’s tax year, and in advance of filing their tax return, in order for the CCUS Credit to be processed upon filing. This will allow the CCUS Credit to have the intended effect of reducing upfront cash costs of investing in CCUS technologies. Projects that expect to have eligible expenses in excess of $100 million over the life of the project will generally be required to undergo an initial project tax assessment prior to claiming the CCUS Credit.
CCUS Credit Rates
The following investment tax credit rates will be available to investors who incur eligible expense. As the government of Canada wants to encourage investors to move quickly to lower emissions, eligible expenses incurred after 2030 through 2040 will be subject to lower investment tax credit rates as set out in the table below.
Eligible expenses incurred between 2022 and 2030
Eligible expenses incurred between 2031 and 2040
Cost of eligible capture equipment used in a direct air capture project
Cost of other eligible capture equipment
Cost of eligible transportation, storage, and use equipment
As described above, eligible uses of the captured CO2 appear to initially be quite narrow, in that the CCUS Credit is only available to CCUS projects to the extent that they permanently store captured CO2. However, the 2022 Budget materials provide that “other CO2 uses could be made eligible in the future, if permanence of storage can be demonstrated and no incremental CO2 emissions result from the use of the product that is produced.” As a result, while enhanced oil recovery would not be an eligible use of the CCUS Credit, this tax incentive may become available to other manufacturers that use CO2 in their production processes (e.g., manufacturing of chemicals, synthetic fuels and other materials such as plastics). The availability of the credit to these businesses will depend, among other things, on what constitutes “permanent” storage and whether manufacturers that reduce net emissions by “recycling” CO2 but do not remove CO2 from the atmosphere qualify for the CCUS Credit.
The 2022 Budget materials also specify that the Federal government will “engage relevant provinces with the expectation that they will further strengthen financial incentives to accelerate the adoption of CCUS technologies by industry.” It remains to be seen whether provinces will offer similar tax incentives.
If you have any questions or wish to discuss the CCUS Credit or any other tax measures introduced in the 2022 Budget, please contact any member of our Tax Group.
Nancy Diep is a partner in the Calgary office of Lawson Lundell. Nancy's practice focuses primarily on the tax aspects of mergers, acquisitions and reorganizations, including cross-border transactions or financings and ...
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