Principal tax measures from Federal Budget 2023 – Part 3: Clean energy initiatives

Budget 2023 – A Made-in-Canada Plan: Strong Middle Class, Affordable Economy, Healthy Future (“Budget 2023”) was tabled by the Department of Finance (“Finance”) on March 28, 2023 (“Budget Day”). The stated focus of Budget 2023 includes targeted inflation relief, stronger public health care and significant investments towards building Canada’s clean economy. Budget 2023 introduced numerous significant income tax proposals touching on personal, business and international income taxation matters.

This post is the third of a three-part series analyzing the principal tax measures in Budget 2023. The first post discussed proposals under the Income Tax Act (Canada) (the “Act”) which primarily affected individuals and private companies. The second post summarized income tax measures focussed on public companies and financial institutions.

In this post, we analyze certain new clean energy and related initiatives outlined in Budget 2023 – including the Clean Hydrogen Investment Tax Credit and Investment Tax Credit for Clean Technology Manufacturing – as well as the expansion or modification of several existing investment tax credits.

Budget 2023 generally did not provide draft legislation for the clean energy initiatives described below. That may be the result of Finance devising those initiatives in relative haste in order to remain competitive with jurisdictions that have adopted similar measures (such as those under the United States’ Inflation Reduction Act). Taxpayers should be mindful of the potential for change if/when draft legislation is released.

Clean Hydrogen Investment Tax Credit

Budget 2023 proposes to introduce the Clean Hydrogen Investment Tax Credit (“Clean Hydrogen ITC”), which was first announced in Budget 2022 and further described in the Fall 2022 Economic Statement. The Clean Hydrogen ITC is geared towards hydrogen production projects and is intended to permit qualifying taxpayers to offset the cost of purchasing and installing certain equipment used to produce hydrogen from electrolysis or natural gas. Property that is used to convert clean hydrogen to clean ammonia would also be eligible (albeit at the lowest credit rate). Credit rates vary from 15 to 40 per cent, depending primarily on the assessed carbon intensity of hydrogen produced (subject to the phase out discussed below). That assessment is subject to strict rules and requires initial and ongoing eligibility verification and compliance.

The Clean Hydrogen ITC applies for properties that are acquired and become available for use on or after Budget Day. Property that becomes available for use in 2034 would be subject to one-half reduction in credit rate. The Clean Hydrogen ITC would be fully phased out for property that becomes available for use after 2034.

Clean Technology Manufacturing Investment Tax Credit

Budget 2023 also proposes to introduce the Clean Technology Manufacturing Investment Tax Credit (“Clean Technology Manufacturing ITC”). The Clean Technology Manufacturing ITC would be equal to 30 per cent of the capital cost of eligible property associated with “eligible activities”, which includes a host of manufacturing and processing activities (such as manufacturing nuclear energy equipment and fuel rods, zero-emission vehicles, equipment for air- and ground-source heat pump systems, and certain renewable energy equipment). It also includes extraction and certain processing activities related to six critical minerals essential for clean technology supply chains: lithium, cobalt, nickel, graphite, copper and rare earth elements.

The Clean Technology Manufacturing ITC would apply to property that is acquired and becomes available for use on or after January 1, 2024. The Clean Technology Manufacturing ITC would have the phase out schedule set out in the table below.

Geothermal energy and the clean technology investment tax credit

In the Fall 2022 Economic Statement, Finance announced that it would be introducing a Clean Technology Investment Tax Credit (“Clean Technology ITC”). At that time, Finance proposed that the tax credit would apply at the rate equal to 30% of the capital cost of investments in certain electricity generation systems, stationary electricity storage systems, low-carbon heat equipment, and industrial zero-emission vehicles and related charging or refueling equipment.

Budget 2023 proposes to expand eligibility of the Clean Technology ITC to include certain geothermal energy systems. Eligible property would include certain equipment used primarily for generating electrical or heat energy solely from geothermal energy, such as piping, pumps, heat exchangers, steam separators, and electrical generating equipment.

The Clean Technology ITC would apply to property acquired and available for use on or after Budget Day (if the property has not been used for any purpose before its acquisition). The Clean Technology ITC would follow the same phase out as the Clean Hydrogen ITC: a one-half credit reduction for property that becomes available for use in 2034, followed by a full phase out for property available for use after 2034.

Investment tax credit for carbon capture, storage and utilization

The Carbon Capture, Storage and Utilization Investment Tax Credit (“CCUS ITC”) was initially announced in Budget 2022. During the summer of 2022, a consultation on initial draft legislative proposals and additional design features was undertaken. Budget 2023 contains draft legislation for certain aspects of the proposed CCUS ITC regime and promises further legislative proposals in the coming months.

The proposed addition design features include:

• expanding the CCUS ITC to cover dual use equipment (i.e., equipment used for both a CCUS process and other process) that is expected to primarily be used to support a CCUS process or hydrogen production eligible for the Clean Hydrogen ITC;
• adding British Columbia as an eligible dedicated geological storage jurisdiction;
• obligating taxpayers to have qualified third parties — rather than Environment and Climate Change Canada — validate processes for using and storing carbon dioxide in concrete to confirm whether eligibility criteria are satisfied; and
• updates to the treatment and recovery of costs related to refurbishing equipment.

Draft legislation has been provided for the knowledge sharing and climate risk disclosure requirements raised in Budget 2022. Knowledge sharing obligations will only attach to CCUS projects that have or are expected to incur $250 million or more in qualified CCUS expenditures over the life of the project. Affected taxpayers will be obligated to produce two knowledge sharing reports: a “construction and completion” report, due six months after the commencement of commercial operations, and an operations report that must be produced annually. Knowledge sharing reports will be publicly available through the Minister of Natural Resources’ website. The required contents of the knowledge sharing report will be fixed in technical guidance documents which the Minister of National Resources will produce and periodically update. Critically, failure to provide a knowledge sharing report will result in a fixed $2 million penalty.

Corporations that have deducted a CCUS tax credit will be required to produce, and make publicly available, annual climate risk disclosure reports. Corporations will be excluded from this requirement if they hold an interest in a CCUS project that has incurred, or is expected to incur, less than $20 million in expenditures. A climate risk disclosure must:

• explain how the corporation’s governance strategies, policies and practices contribute to achieving Canada’s commitments under the Paris Agreement and the associated goal of net-zero emissions by 2050; and
• describe the climate-related risks and opportunities for the corporation based on certain “thematic areas” (e.g. actual and potential impacts on the corporation’s businesses, strategy and financial planning, processes used to identify, assess and manage risks and opportunities, etc.).

A climate risk disclosure report will be required in the first year a taxpayer deducts a CCUS tax credit and each subsequent year up to the 21^st calendar year after the CCUS project commenced commercial operations. The report must be made available within nine months after the relevant reporting year-end, and would qualify if accessible through the corporation’s website for at least three years after the reporting due date. Failure to satisfy these reporting obligations will result in a penalty equal to the lesser of 4% of all CCUS tax credits deducted in all taxation years that ended before the reporting due date and $1 million.

The climate risk disclosure reporting rules are a significant ongoing obligation with the potential for severe penalization. It will be interesting to monitor whether these obligations are relaxed or the penalty softened in the future.

Labour Requirements

In Budget 2023, Finance unveiled labour requirements that will attach to certain clean investment tax credits. Failure to meet the labour requirements will generally result in a 10 per cent reduction in the ITC rate, and may eliminate the ITC entirely.

The labour requirements consist of a prevailing wage and apprenticeship component. The prevailing wage requirement seeks to ensure that covered workers are compensated at a level that meets or exceeds a relevant wage (comprised of wages, benefits and pension contributions) determined with reference to an “eligible collective agreement”. Such agreements are generally determined with reference to standard multi-employer collective bargaining agreements for the region. Businesses may pay their workers in accordance with the agreement or at or above the prevailing wage it establishes.

The apprenticeship requirement requires that, in a given taxation year, 10 per cent or more of the total relevant labour hours are performed by registered apprentices. Relevant labour hours are generally those spent on subsidized project elements and comprised of duties that correspond to those performed by a journeyperson in a Red Seal trade.

The labour requirements apply to employees as well as contractors and subcontractors. However, they only apply to work on project elements subsidized by a relevant ITC and do not apply in respect of workers whose duties are primarily administrative, clerical, supervisory, or executive.

Zero-emission technology manufacturers

The zero-emission technology manufacturers (“ZETM”) scheme reduces Federal corporate income tax rates by up to half for certain zero-emission technology manufacturers. Budget 2023 proposes to expand the eligible activities and timeframe applicable to the ZETM scheme. Specifically, for years beginning after 2023, income from certain nuclear manufacturing and processing activities – such as manufacturing of nuclear energy equipment, processing or recycling of nuclear fuels and heavy water, and manufacturing of nuclear fuel rods – will also qualify for the rate reduction. Budget 2023 also proposed to extend the availability of reduced rates for all qualifying income by three years, such that the measures would only be fully phased out for taxation years beginning after 2034.

Flow-through shares and critical mineral exploration tax credit – lithium from brines

Under flow-through share agreements, corporations may “flow through” Canadian exploration expense and Canadian development expenses to investors, who may then deduct those expenses (either immediately or over time) in calculating their taxable income.

The Critical Mineral Exploration Tax Credit (the “CMETC”) is a 30% non-refundable tax credit that allows individuals (other than trusts) to invest in flow-through shares and deduct certain specified critical mineral exploration expenses incurred by the corporation and renounced to the individual under a flow-through share agreement.

Budget 2023 proposes to expand the flow-through share regime by including lithium from brines as a mineral resource. The CMETC would also be expanded to include lithium from brines. Those measures are consistent with the government’s broader focus on clean energy initiatives, as lithium is essential in the manufacturing of several clean technologies.

Under the proposed changes, corporations that incur eligible expenses related to lithium from brines after Budget Day may flow-through these qualifying expenses to investors. Thus, individual investors may claim the CMETC on qualifying expenses for flow-through share agreements entered into after Budget Day and before April 2027.