Hollywood loves science fiction and the future. So-called “genre” films, featuring futuristic scenarios, humans with fantastic supernatural abilities, and new technologies dominate the cinemas and streaming market. Many commentators have speculated that the enduring fascination with such productions lies in the way they hold a mirror to contemporary society, and explore important questions on ways in which it might or should change. (Other, more cynical commentators hold that such films make big dollars, and the only really material question for producers and studios is “What’s in it for me?”)
Although increasingly viable technological advances in hydrogen production promise to help with real-world problems like fossil fuel depletion, carbon pollution and climate change, hydrogen does not seem to have captured Hollywood’s imagination – and therefore the general excitement of the public – as much as some other emerging fields such as artificial intelligence or genetic manipulation. There are no popular film or television series (so far as the writers are aware) about hydrogen-powered super robots or mad scientist villains plotting to corner the hydrogen market. No doubt any such endeavour would be a major success, once Hollywood producers realize what’s in it for them.
Nevertheless, hydrogen remains the way of the future, and nothing says the way of the future like refundable tax credits. The federal government announced in its 2022 Fall Economic Statement that an investment tax credit was coming for clean hydrogen, but the uncertainty was how best to implement such a program. An outline for such a program could be found south of the border in the U.S. Inflation Reduction Act (the “IRA“). The IRA provides support to clean hydrogen projects, beginning with projects producing 4.0 kilograms (“kg“) of CO2 equivalent (“CO2e“) or less per kg of hydrogen. The IRA tax credits (which may be claimed either on the basis of production or as a credit towards the purchase of equipment) reach the highest level for those projects that produce emissions that are 0.45 kg of CO2e or less per kg of hydrogen. In the 2022 Fall Economic Statement, the Canadian government committed to providing a level playing field between Canada and the United States for jobs and business investment and launched a consultation process, designed to ensure that a corresponding clean hydrogen incentive program would work in the Canadian context.
Fast forward to Budget 2023, and the clean hydrogen investment tax credit (the “CH Tax Credit“) has now been proposed. The CH Tax Credit was established as a refundable tax credit which means that if you qualify and claim the credit then such credit can result in a refund paid to you even if you have no income tax payable. Appearances to the contrary, this is not Hollywood science fiction.
The gatekeeping question to ask is: “who is eligible to claim the CH Tax Credit?” The answer is that only projects that only produce all, or substantially all, hydrogen through certain approved processes will be eligible. In particular, 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 (“CCUS“)). The production of excess electricity available for sale back into the grid will also not be counted towards the ‘all or substantially all hydrogen’ test.
The next question is what constitutes “Eligible Equipment”? Generally speaking, this is intended to include the following equipment, made available for use in Canada:
- Equipment required to produce hydrogen from electrolysis of water (so long as all or substantially all of the use of such equipment is for hydrogen production);
- Equipment required to produce hydrogen from natural gas with emissions abated using CCUS (so long as all or substantially all of the use of such equipment is for the production of hydrogen), and excluding Class 57 or Class 58 equipment eligible for the Investment Tax Credit for CCUS);
- Oxygen production equipment used to produce hydrogen (so long as the resulting CO2 is captured by a CCUS process);
- Equipment producing heat and/or power from natural gas or hydrogen;
- Dual use power or heat production equipment (so long as more than 50% of the energy is used to support the CCUS process or hydrogen production that is eligible for the proposed CH Tax Credit); and
- Property required to convert clean hydrogen to clean ammonia (though such property is only eligible for the lower credit rate described below).
The million dollar question, or tax incentivized question, is the same for Hollywood and hydrogen producers alike: “what’s in it for me?” The refundable tax credits, calculated with reference to the cost of purchasing and installing Eligible Equipment, will be available on a sliding scale, based upon the carbon intensity (“CI“) of the hydrogen produced. The proposed CH Tax Credits rates are:
- 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.
Budget 2023 proposes that the CI be calculated “cradle-to-gate,” taking into account emissions commencing upstream (most relevantly from the production of natural gas) through to the exit of hydrogen from the production facility.
These credit rates may be reduced by 10% if certain labour requirements are not met (to a minimum of 0% during the 2034 phase out period discussed below). These labour requirements apply to workers whose duties are primarily manual or physical in nature, but not to those whose duties are primarily administrative, clerical, supervisory, or executive. There are two prongs to such requirements:
- Prevailing wage requirement – workers must be compensated at a level that meets or exceeds the relevant wage as specified in an eligible collective agreement. This could be satisfied through a combination of wages, pension contributions and benefits. Furthermore, a business could pay “corrective” remuneration and penalties to resolve non-compliance.
- Apprenticeship requirement – not less than 10% of the total labour hours performed by covered workers must be performed by registered apprentices.
Measuring carbon intensity (in order to determine the CH Tax Credit for which one may qualify) will be done based upon the government’s Fuel Life Cycle Assessment Model maintained by Environment and Climate Change Canada. A CI assessment must be submitted to the government for verification. The “verification” process may be summarized as follows:
- Step 1 – Complete a front-end engineering design study.
- Step 2 – Undergo an initial project CI assessment to determine the expected CI of the hydrogen produced. This determination would establish the credit rate available. However, any project that undergoes a significant redesign will need to be reassessed.
Verification is just one hoop to jump through, however. Projects must also demonstrate that they are achieving the assessed production level in order to maintain their eligibility for the CH Tax Credit. The assessment is intended to occur over an as-yet unspecified period of time, verified by an independent third party. The CH Tax Credit could be subject to recovery based upon the difference between the assessed CI tier and the actual CI tier observed during production.
As an aside, Budget 2023, unlike Hollywood, does not go back to the proverbial well and permit double dipping. Taxpayers will only be able to claim one of the CH Tax Credit, the Investment Tax Credit for CCUS, the Investment Tax Credit for Clean Technologies, the Investment Tax Credit for Clean Electricity or the Investment Tax Credit for Clean Technology Manufacturing, where a property is eligible for more than one tax credit. However, a particular project could claim multiple tax credits if different types of eligible property are part of such project.
The CH Tax Credit is available for property acquired and that becomes available for use after Budget Day 2023, being March 28, 2023. However, time is of the essence and the CH Tax Credit, unlike diamonds, is not forever and will be phased out in 2034. Eligible Equipment which becomes available for use in 2034 will still be eligible for the CH Tax Credit reduced by 50%. Eligible Equipment which becomes available for use after 2034 will not be eligible for the CH Tax Credit.
For hydrogen to realize its potential as a future-saving fuel, new perceptions and more optimistic narratives will need to take hold, and the important tax reforms being implemented in Canada and the U.S. will help establish a robust and reliable hydrogen market. A multibillion dollar Hollywood franchise about a dashing renegade who hunts criminals on his hydrogen-fuelled motorcycle would likely help to shift popular attitudes, but that should perhaps be left to the science fiction writers for the time being.
Should you have any questions or concerns, please feel free to reach out to a member of Miller Thomson’s Corporate Tax group.
