On August 4, 2023, the Department of Finance ("Finance") released a substantive piece of draft legislation for a number of investment tax credits previously announced by Finance and aimed at renewable and clean energy sectors (the "Proposed Legislation"). The Proposed Legislation addresses the new Investment Tax Credit for Carbon Capture, Utilization and Storage ("CCUS"), changes to the Zero-Admission Technology Manufacturing Deduction, and the tax treatment of lithium recovered from brine deposits. This Proposed Legislation also addresses prior proposals from Finance related to the Clean Technology Investment Tax Credit, which is separately discussed in its own standalone update, as well as mandatory disclosure reporting, alternative minimum tax and additional matters, certain of which are detailed in our separate bulletin.
The below is a review of the Proposed Legislation and the resulting consequences this legislation has for taxpayers interested in investing in renewable energy projects.
Carbon Capture, Utilization and Storage
The Carbon Capture, Utilization and Storage investment tax credit was first announced in the 2022 Canadian Federal Budget to incentivize investment into carbon capturing technology. It was further expanded upon by Finance this last Spring in the 2023 Federal Canadian Budget ("Budget 2023"). The CCUS tax credit is meant to apply to projects that incurred eligible expenses starting January 1, 2022. The CCUS credit has varying rates of refund, which are based on the different types of projects encompassed in the CCUS framework and are as follows:
- 60% for investments in equipment that uses direct air capture equipment;
- 50% for all other CCUS projects; and
- 37.5% for equipment meant for transportation, storage and use.
These rates will remain the same from 2022 through 2030. Following this period, each rate will be reduced by half for the period from 2031 through 2040, when they will be phased out. The CCUS credit is available for taxable Canadian corporations only.
Dual Use Equipment
One of the biggest changes that Budget 2023 proposed to make with regards to CCUS was the inclusion of certain expenditures on "dual use equipment" for the CCUS tax credit. The proposed definition of dual use equipment includes a number of properties, which have been introduced to the Income Tax Regulations (the "Regulations") under the new Class 57 property heading. The key attribute for property that falls under the dual use equipment definition is that it collects, recovers, treats, or recirculates water, in support of a CCUS project, while also producing electricity, heat, or a combination of the two. Taxpayers seeking to qualify under the first two categories of dual use equipment will need to have their property verified by the Minister of Natural Resources (the "Minister") in order to receive credit for their expenditures.
Qualified CCUS Projects and Expenditures
In order to be eligible for the CCUS tax credit, a project must be deemed to be a "qualified CCUS project". A taxpayer looking to claim the CCUS tax credit is expected to support the capturing of carbon dioxide in Canada. The extent of this support will be determined based on a project's most recent project plan, which must be confirmed by the Minister. In particular, the Minister must certify that the most recent project plan demonstrates the project's eligible use percentage will be equal to or exceed 10% across a specified period. Projects will not qualify where they are operated to service a "unit" (as defined under the Reduction of Carbon Dioxide Emissions from Coal-fired Generation of Electricity Regulations) with a commissioning date on or before April 7, 2022. It must also not be undertaken for the purpose of complying with emission standards that apply, or will apply, under federal regulations.
Four types of expenditures may qualify for the CCUS credit, namely: qualified carbon capture expenditures, qualified carbon transportation expenditures, qualified carbon storage expenditures, and qualified carbon use expenditures.
The Tax Credit
There are two types of CCUS tax credit: the "Cumulative Development Tax Credit" (the "Cumulative Credit") and the "CCUS refurbishment tax credit" (the "Refurbishment Credit"). The amount of the credit will be determined by finding the total amount of (i) the taxpayer's Cumulative Credit for the current tax year which exceeds their Cumulative Credit from the previous year and (ii) the taxpayer's Refurbishment Credit for the current tax year. The Cumulative Credit is for expenses incurred before the project begins operations (if incurred after January 1, 2022), while the Refurbishment Credit is for expenses incurred after the project begins operations.
A partnership will allocate the CCUS credits to each partner (as long as they are a taxable Canadian corporation) in an amount equal to their reasonable share. Limited partners under CCUS are subject to common investment tax credit rules under the Income Tax Act.
The Proposed Legislation also includes a claw back mechanism in the event a taxpayer is granted a CCUS tax credit without fulfilling the applicable requirements. For example, if a CCUS project's eligible use percentage is reduced, either before the project begins operations or during the project's operation. However, the Proposed Legislation contemplates certain safe harbours in extraordinary circumstances outside the taxpayer's control.
The Proposed Legislation also includes a recovery tax in certain circumstances where a taxpayer disposes of the CCUS property. This can similarly be avoided if the property is sold to a taxable Canadian corporation and both parties make a joint election. This mechanism allows the purchaser to simply acquire all the incurred CCUS credits the vendor has been granted.
The Proposed Legislation includes detailed rules relating to reporting and compliance.
Zero-Emission Technology Manufacturers
The Proposed Legislation also addresses the available deduction for manufacturers of zero-emission technology. Finance has proposed to change the formula for determining the amount of a corporation's zero-admission technology manufacturing deduction. These changes extend the availability of the deduction for manufacturing profits in taxation years that begin after 2021 and before 2035. The formula for calculating the deduction has been changed to ensure the full tax reduction applies in the years after 2021 and before 2032. Following this, the rate of deduction will diminish for taxation years beginning after 2031. Lastly, the Proposed Legislation also expands the list of eligible property under the definition of "qualified zero-emission technology manufacturing activities" to include: nuclear energy equipment, heavy water, nuclear fuels, and nuclear fuel rods.
Flow-Through Shares and Critical Mineral Exploration Tax Credit – Lithium from Brines
The definitions of Canadian development expense and Canadian exploration expense have been expanded by the Proposed Legislation to allow expenses related to the exploration and extraction of lithium from a brine deposit to be renounced to flow-through shareholders.
The Proposed Legislation also addresses prior proposals to expand the Critical Mineral Exploration Tax Credit ("CMETC") to lithium from brines.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.