Budget 2023 provides much-anticipated details of the ITC, which was first announced as part of the 2022 Fall Economic Statement (FES). The FES, which we discussed in our previous Client Alert, included major investment incentives for clean energy and hydrogen to help Canada meet its clean energy goals and ensure Canadian companies remain globally competitive against the backdrop of strong support mechanisms in other nations. United States Inflation Reduction Act (IRA).
Tax credit structure
The ITC will be available to projects that produce hydrogen, whether those projects also produce CO2 (as long as the CO2 is captured and stored or used) or produce and sell excess electricity. Eligible projects initially include facilities to produce hydrogen from natural gas through electrolysis or carbon capture, utilization and storage (CCUS), but other forms of production will be evaluated further by the government. Credits will be refundable and claimable when eligible equipment is available for use.
The ITC will apply to the cost of purchasing and installing equipment required to produce hydrogen from electrolysis or natural gas plus CCUS. Note, however, that equipment that is already eligible for Canada’s CCUS ITC is not eligible for the Clean Hydrogen ITC. In addition, in some cases, the clean hydrogen ITC may apply to equipment that produces heat and/or power from natural gas or hydrogen or dual-use power or heat generation equipment. However, broader project costs, such as feasibility studies, front-end engineering design studies and operating expenses are ineligible for ITC.
Additionally, the ITC will extend a 15% tax credit to equipment used to convert hydrogen into ammonia for transportation fuel, as long as the ammonia production is related to the production of clean hydrogen.
The ITC will be determined using the following tiered structure based on life cycle carbon intensity (measured as kilograms of CO2e of hydrogen (H2) produced), assuming that labor conditions are met:
Total life cycle CO2 intensity will be assessed based on the government’s Fuel Life Cycle Assessment (LCA) model maintained by Environment and Climate Change Canada. Emissions will be calculated “cradle-to-gate”, meaning that the calculation considers upstream emissions through the point where the hydrogen exits the facility gate and therefore omits consideration of any downstream emissions.
For projects using grid-electricity, the calculation must include the source of power. However, specific details—such as rules on matching deadlines, rules promoting additionality principles or whether power must be purchased from a Canadian generator to qualify—have not yet been provided.
The credit is expected to cost $4.5 billion over five years starting in 2023 – 2024, and an additional $6.6 billion CAD from 2028 – 2029 through 2034 – 2035. The credit will be applicable to the property acquired or later made available for use. Not effective after January 1, 2024, and 2034, subject to a phase-out beginning in 2032.
Comparing Canadian Investment Tax Credit and US Inflation Reduction Act Tax Structures
The Canadian ITC allows qualified producers to receive a tax credit equal to a specified percentage of their capital expenditures (an investment tax credit). In contrast, the US IRA subsidizes the production of hydrogen by allowing producers to obtain it. either A credit equal to a certain percentage of their capital expenditure (investment tax credit) or A tax credit equal to a specified dollar value per kilogram of hydrogen produced (production tax credit). The IRA tax credit is determined using the following tiered structure based on life cycle carbon intensity (measured as hydrogen (H2) produced per kg CO2e):
* Note that the above ITC and PTC amounts are dependent on the eligibility feature for the 5X multiplier. It applies to facilities with a maximum net output of less than 1MW, facilities that began construction by January 29, 2023, or facilities that meet the prevailing wage and apprenticeship requirements of the IRA.
Furthermore, as discussed above, the proposed Canadian ITC is only available to producers using electrolysis or natural gas plus CCUS to produce hydrogen, while the US IRA is process-neutral to receive tax credits. Under the IRA, producers can use a variety of techniques to qualify for the tax credit. However, both the Canadian ITC and the US IRA only receive credits if the emission intensity towards H2 production is below the 4 kg CO2 cap.
Unlike the IRA, the Canadian ITC does not provide “bonus” credits based on meeting certain conditions of hydrogen production (eg, location in the Energy Community or meeting domestic content standards). However, both frameworks require producers to meet prevailing wage requirements to maximize credit.
Wages and Apprenticeship Requirements
Canada’s proposed ITC would require projects to meet certain wage and apprenticeship requirements to receive the same maximum credits as the US IRA. If the business does not meet these requirements, the credit rate will be reduced by 10% for each carbon-intensity tier.
To meet these requirements, businesses must ensure that all covered workers are paid a total compensation package that is equal to the prevailing wage. Prevailing wages are based on union compensation—including total benefits and pension contributions—under the most recent, widely applicable multi-employer collective bargaining agreement, or related project labor agreements, within the area in which the relevant project-worker is employed. In addition, a business must demonstrate that 10% of its total trade hours were performed by registered apprentices for work on eligible project elements in the relevant tax year. These requirements will apply to work performed on or after October 1, 2023.
In contrast, while the IRA includes prevailing wage requirements, the prevailing wage is defined by reference to the U.S. Department of Labor’s published prevailing rates for relevant work in a particular field rather than by regional union agreements. In addition, the IRA’s wage and apprenticeship requirements began on January 29, 2023, approximately eight months before the proposed Canadian ITC wage and apprenticeship requirements take effect.
Currently, no date has been set for the Budget 2023 to be voted on in Parliament. Although Trudeau’s Liberal Party lacks a majority in parliament, the party is supported by the New Democratic Party, ensuring that the Prime Minister has a vote for the 2023 budget. .
Pillsbury provides legal support on energy matters to many branches of the Canadian government, Canadian energy producers, suppliers, laboratories and manufacturers, and is a member of the Canadian Nuclear Association. Our team is ready to support in-bound and out-bound investments in this vibrant and dynamic energy market.