Canada continues to work toward a sustainable, low-carbon economy, using tax incentives to encourage investment in clean energy infrastructure.
In the 2022 Federal Budget, the government announced that it would engage experts to establish investment tax credits (“ITCs”) focused on net-zero technologies, battery storage solutions, and clean hydrogen.[1] Following those consultations, details about several tax incentives have been announced. Key announcements were included in the 2022 Fall Economic Statement, 2023 Federal Budget (“Budget 2023”), 2023 Fall Economic Statement (“2023 FES”), and, most recently, the 2024 Federal Budget (the “Budget 2024”).
This article provides a summary of recent developments regarding the clean hydrogen investment tax credit (“CH ITC”).
Overview Of The Clean Hydrogen Tax Credit
The CH ITC is a refundable tax credit for projects which produce all, or substantially all, hydrogen through certain approved processes. The credit is available for the cost of purchasing and installing “Eligible Equipment” for projects producing hydrogen from electrolysis or natural gas (so long as emissions are abated using carbon capture, utilization and storage).
The proposed CH ITC rate available for a particular project is based on the carbon intensity (“CI“) of the hydrogen produced:
- 40% for a CI less than 0.75 kg per kg of hydrogen;
- 25% for a CI greater than or equal to 0.75 kg, but less than 2 kg per kg of hydrogen; and
- 15% for a CI greater than or equal to 2 kg, but less than 4 kg per kg of hydrogen.
The CI is proposed to be calculated from “cradle-to-gate”, considering upstream emissions through to the point where hydrogen would exit the production facility. The above credit rates may be reduced by 10% if certain prevailing wage and apprenticeship labour requirements are not met.
The CH ITC is proposed to be available for Eligible Equipment acquired and that becomes available for use on or after March 28, 2023. The credit rate is proposed to be reduced by 50% for Eligible Equipment which becomes available for use in 2034 and will not be available after 2034.
2023 Fall Economic Statement
The 2023 FES provides additional details about the CH ITC and expanded the scope of the credit.
Ammonia Production
Budget 2023 announced that property that is required to convert clean hydrogen to clean ammonia would be eligible for the CHI ITC at a rate of 15%. The 2023 FES provided details and proposed the following conditions:
- The taxpayer that is producing the ammonia must use their own hydrogen feedstock for ammonia production, and the hydrogen feedstock must come from clean hydrogen projects of the taxpayer that are eligible for the CH ITC;
- The clean hydrogen projects have sufficient production capacity to satisfy the needs of the taxpayer’s ammonia production facility; and
- The taxpayer demonstrates the feasibility of transporting the hydrogen from the hydrogen production facilities to the ammonia production facility if they are not co-located.
The 2023 FES also specified that in facilities producing both hydrogen and ammonia, the cost of equipment serving both purposes (i.e., an air separation unit) would be divided between hydrogen and ammonia equipment based on their relative usage between the hydrogen and ammonia production.
Power Purchase Agreements
Budget 2023 announced that certain Power Purchase Agreements (“PPAs“), and other similar instruments, would be eligible for purposes of calculating the project’s CI. The 2023 FES provided additional details and proposed the following conditions:
- The purchased electricity is sourced from hydro-, solar-, or wind-powered generation that:
- first commenced production on or after March 28, 2023, and no more than one year before the initial project CI assessment for the related clean hydrogen project is submitted; and
- is located in the same province or territory as the clean hydrogen project and is connected to the electricity grid of that province or territory.
- Taxpayers would need to demonstrate that the energy being purchased under these instruments is for the operation of the clean hydrogen project.
To calculate a project’s CI, the electricity purchased through PPAs, or similar instruments, would be considered based on the number of years the eligible instrument is expected to be in place during the project’s first 20 years of operation (which is the assumed notional service life of a clean hydrogen project).
Renewable Natural Gas
The 2023 FES proposed that some hydrogen projects may use renewable natural gas (“RNG“) in place of fossil-derived natural gas to decrease the CI of the projects when calculating the CH ITC. There are several eligibility conditions that must be met.
Similar to the PPAs, to calculate a project’s CI, the contribution of RNG would be considered based on the number of years the agreement is expected to be in place during the project’s first 20 years of operation. The CI of the purchased RNG would correspond to the CI assessed under the Clean Fuel Regulations.
Initial Project Assessment and Validation
2023 Budget indicated that the initial CI assessment would determine the expected CI of the hydrogen that would be produced by validating: (1) the modelling of the project using the Fuel Life Cycle Assessment (“LCA”) Model, and (2) that the project design can reasonably be expected to achieve the modelled outcomes.
The 2023 FES provided additional details:
- Requirement that the initial project CI assessment be validated by a third party and a validation report be prepared by a Canadian engineering firm that meet certain criteria, including expertise in modelling using the Fuel LCA Model.
- Submissions of an initial project CI assessment and third-party validation report, including any required documentation, to Natural Resources Canada.
- Once Natural Resources Canada has validated the expected CI of the project, the CH ITC would be administered by the Canada Revenue Agency.
Compliance Requirements and Recovery Mechanisms
Budget 2023 indicated that once a project is operating, if the CI of the hydrogen produced falls below the tier for which the project was assessed, the taxpayer could be subject to a recovery of tax credit amounts.
The 2023 FES provided further details. Projects are proposed to be subject to a one-time verification, based on a 5-year compliance period. Over those 5 years, the projects would calculate and annually report on the effective CI of hydrogen produced. Projects would need to have the CI of the hydrogen verified by a different third-party Canadian engineering firm than the engineering firm which validated the initial CI assessment.
Budget 2024
The federal government recently confirmed its intention to proceed with the legislative proposals released on December 20, 2023 with respect to the CH ITC. Budget 2024 indicated that legislation will be introduced soon.
Seizing Opportunities For Innovation And Growth
The ongoing development of the CH ITC reflects one of Canada’s efforts to incentivize investment in clean energy infrastructure, contributing to the nation’s broader environmental and economic objectives. Legislation is expected to be introduced in Parliament soon but could be subject to amendment.
If you have any questions regarding the CH ITC, including eligibility requirements or compliance obligations, contact a member of Miller Thomson LLP’s Corporate Tax Group or ESG and Carbon Finance Group.
[1] Clean hydrogen refers to both hydrogen produced through electrolysis powered from renewable sources (green hydrogen) and hydrogen produced from natural gas in conjunction with carbon capture and storage by steam methane reforming (blue hydrogen).
