Tax Insights: Finance releases draft legislation for the clean hydrogen and clean technology manufacturing investment tax credits

January 12, 2024

Issue 2024-01

In brief

On December 20, 2023, the Department of Finance released draft legislative proposals on several measures announced or referred to in the 2023 federal Fall Economic Statement¹ (FES). Included in this release is the first draft of legislation for the clean hydrogen investment tax credit (Clean Hydrogen ITC) and the clean technology manufacturing investment tax credit (Clean Technology Manufacturing ITC).²

The Clean Hydrogen ITC will provide a refundable investment tax credit (ITC) of up to 40% on eligible expenses incurred for property that produces hydrogen and becomes available for use after March 27, 2023 and before 2035. The draft legislation covers new definitions for eligible projects and hydrogen production pathways, dual-use equipment and recapture, as well as confirming details released in the FES.

The Clean Technology Manufacturing ITC will offer a refundable ITC of up to 30% of the capital cost of eligible new property associated with qualifying activities that is acquired and becomes available for use after 2023 and before 2035. The draft legislation outlines:

new definitions for qualifying materials (lithium, cobalt, nickel, copper, rare earth elements and graphite) and qualifying mineral activities (extraction from a mineral deposit or tailing pond, mineral processing, recycling, graphite synthesis/spheronization)
eligible associated capital cost allowance (CCA) property classes

The federal government has launched a public consultation on these proposals, with comments to be submitted by February 5, 2024. This Tax Insights provides an overview of the draft legislation³ for these two “clean economy” refundable ITCs and considerations for taxpayers who intend to claim them.

In detail

Clean Hydrogen ITC

Overview

The Clean Hydrogen ITC, which was introduced in the 2023 federal budget, is intended to promote the development and use of clean hydrogen in Canada. It provides a refundable tax credit of up to 40%, depending on the carbon intensity of the hydrogen produced, on eligible expenses incurred for property that produces hydrogen and becomes available for use after March 27, 2023. The ITC rates are reduced by 50% in 2034 and fully phased out after 2034. Property used to convert clean hydrogen to clean ammonia is also eligible at a 15% ITC rate. Starting November 28, 2023, claimants must also meet certain labour requirements to qualify for the full ITC rate; if they are not met, the ITC rate is reduced by 10 percentage points.

In its FES, the federal government provided additional details on the Clean Hydrogen ITC relating to the eligibility of renewable natural gas for use in qualifying projects, the 15% ITC available for clean ammonia production and carbon intensity reporting/verification/recapture mechanisms, among other details.⁴ The draft legislation confirms the overview provided in the FES and provides more definitions on the Clean Hydrogen ITC, as follows:

Eligible clean hydrogen property – Equipment that qualifies as eligible clean hydrogen property must produce hydrogen on an all or substantially all basis from an eligible pathway, either by:
- electrolysis of water, or
- natural gas reforming (any use of fossil fuels must be subject to capture by a carbon capture, utilization and storage [CCUS] process); this may include pre‑reformers, auto‑thermal reformers, steam methane reformers, pre-heating equipment, syngas coolers, shift reactors, purification equipment, fired heaters, water treatment and conditioning equipment, equipment used in compression and storage of hydrogen, oxygen production equipment and methanizers
  
  Eligible clean hydrogen property also includes:
- clean ammonia equipment, dual‑use electricity and heat equipment or dual-use hydrogen and ammonia equipment
- ancillary equipment that is used solely to support the functioning of any of the above within a hydrogen or ammonia production process and is physically and functionally integrated with that equipment, and includes systems such as electrical, feed supply, cooling, process material storage, process waste management, or oxygen or nitrogen distribution
- safety and integrity systems, which may be used as part of a control or monitoring system

The equipment must be situated in Canada and not be an “excluded property.”

Excluded property – This means:
- certain property that is part of a CCUS project in CCA class 57 or 58
- equipment used for off‑site hydrogen or ammonia transmission, transportation or distribution
- automotive vehicles or related refuelling equipment
Capital costs of clean hydrogen property – Dual‑use electricity and heat equipment must be allocated into two separate capital cost amounts, based on the percentage of expected use attributable to clean ammonia and clean hydrogen.

Considerations

CCA classes – Except for CCA class 43.1 for electrolysis equipment, eligible CCA classes were not specified for the various natural gas reforming routes for hydrogen and/or ammonia production.
Filing – A prescribed form in respect of the clean hydrogen project must be submitted by the taxpayer with its tax return for each taxation year that begins during the compliance period. In addition, each failure to file an annual compliance report is liable to a penalty.

Clean Technology Manufacturing ITC

Overview

The Clean Technology Manufacturing ITC, which was also introduced in the 2023 federal budget, is intended to encourage investment in clean technology manufacturing and processing and critical mineral extraction and processing. It provides a refundable tax credit equal to 30% of the capital cost of eligible new property associated with qualifying activities that is acquired and becomes available for use after 2023. The rate is reduced to 20% in 2032, 10% in 2033, 5% in 2034 and fully phased out after 2034.

The draft legislation provides details on the Clean Technology Manufacturing ITC, as follows:

Clean technology manufacturing (CTM) property – This includes approximately 10 CCA classes (in Schedule II of the Income Tax Regulations), provided it is used for qualifying activities (see “CTM use” below) and is not an “excluded property,” as follows:
- class 8: paragraph (a) or (c) or paragraph (b) if the word “solely” were read as “primarily” and if the word “building” were read as “structure”
- class 43: paragraph (a)
- class 53
- class 10: subparagraphs (k)(i) and (k)(ii)
- class 41 and class 41.2: paragraph (b) that would otherwise be included in Class 10 above
- class 43.1 and class 43.2 that would otherwise be included in the above
- class 10 or class 38: paragraph (a) or (e), but excluding any property that is designed or adapted for use on streets and highways
- class 56

The equipment must be situated in Canada and intended for use exclusively in Canada.

CTM use – This is defined as property used:
- all or substantially all for activities described in paragraph (a) or (c) of the definition “qualified zero‑emission technology manufacturing activities” in section 5202 of the Income Tax Regulations, or
- in a qualifying mineral activity producing all or substantially all qualifying materials

It does not include hydrogen production by electrolysis and biofuel production, which are eligible for the Clean Hydrogen ITC and the Clean Technology ITC biomass expansion, respectively.

Excluded property – This is defined as “any property used in the production of battery cells or modules if the production has benefited from, or can reasonably be expected to benefit from, support under a contribution agreement with the Government of Canada.”
Qualifying materials – These are defined as lithium, cobalt, nickel, copper, rare earth elements (i.e. 15 elements referred to as the lanthanide series in the periodic table of elements, plus scandium and yttrium) and graphite.
Qualifying mineral activities – These are:
- extraction of resources from a mineral deposit or tailing pond
- mineral processing activities (e.g. crushing, screening, froth flotation, calcinating, smelting, refining, electrodeposition, etc.) that occurs prior to or as part of a process at a mine site, well site, tailing pond, mill, smelter or refinery, to:
  - increase the purity of at least one qualifying material, or
  - produce a material with non-trace amounts of a single qualifying material, and without non-trace amounts of any elements other than permitted elements (meaning hydrogen, carbon, nitrogen, oxygen, phosphorus, sulfur, selenium, a halogen or a noble gas)
- recycling activities
- graphite synthesis (during or after the graphitization stage) involving a mineral processing activity substantially similar to the above
- graphite spheronization activities or coating of spheronized graphite.
Recapture – An ITC received by a taxpayer in respect of CTM property acquired in the year or in any of the preceding 10 calendar years will be recaptured in the taxation year if, in that year, the taxpayer has:
- converted the property to a non‑CTM use
- exported the property from Canada, or
- disposed of the property without having previously exported it or converted it to a non‑CTM use
Labour requirements – The Clean Technology Manufacturing ITC does not require claimants to meet certain labour requirements to qualify for full ITC rates (unlike the Clean Hydrogen ITC, see above). This is confirmed by the draft legislation, because the legislation relating to the labour requirements does not refer to the Clean Technology Manufacturing ITC.

Considerations

Battery cells or battery modules – In the “excluded property” definition, distinguishing between a “contribution agreement” and an “excluded loan” may require clarification. An excluded loan is defined as a loan evidenced in writing (other than a forgivable loan), provided by a payer that can be a government, municipality or other public authority in Canada. Further analysis may be required in the event that a battery or battery module project benefits from more than one source of government support.
Mineral processing activities – It is unclear what additional documentation, such as chemical composition assays, may be required to demonstrate the eligibility of beneficiation process steps, particularly if source ores contain low concentrations of qualifying materials and a high proportion of gangue composed of non‑permitted elements.
Graphite – Producing graphite from captured carbon dioxide was not included as an eligible use for the CCUS ITC. However, certain aspects of the process could be a qualifying mineral activity for the Clean Technology Manufacturing ITC.
Reporting requirements – The draft legislation does not comment on the reporting requirements for the Clean Technology Manufacturing ITC, but the application guidelines are expected to provide the relevant procedural information for claimants.

The takeaway

The draft legislation for the Clean Hydrogen ITC and Clean Technology Manufacturing ITC was released according to the timeline published in the FES. However, the absence of explanatory notes that typically accompany draft legislation is unfortunate as the deadline for feedback is February 5, 2024, and the federal government’s plan, as indicated in the FES, is to introduce final legislation in Parliament in “early 2024.”

For both ITCs, the CCA classification appears to be complex for the eligible property associated with the ITCs, although it is interesting that the Clean Technology Manufacturing ITC includes CCA classes 43.1 and 43.2 equipment as well as subsets of eight other CCA classes. With different reporting and compliance obligations for each of the four “clean economy” ITCs for which legislation (or draft legislation) has been released, companies intending to claim more than one ITC will need to consider ongoing documentation practices and filing deadlines for the various submissions. This also includes satisfying the labour requirements that are worth ten percentage points, where applicable.

^{1. For more information, see our Tax Insights “2023 Federal Fall Economic Statement: Tax highlights.”

2. In addition to the Clean Hydrogen ITC and the Clean Technology Manufacturing ITC, the federal government has proposed three other “clean economy” refundable investment tax credits (ITCs): Clean Technology ITC, Carbon Capture, Utilization and Storage (CCUS) ITC and Clean Electricity ITC. For a summary of their status, see our Tax Insights “Clean economy investment tax credits (Fall 2023 update).”

3. At the date of publication, the Department of Finance has not released explanatory notes for this draft legislation. This Tax Insights will be revised if any explanatory notes affect the information provided.

4. For more information, see our Tax Insights “Clean economy investment tax credits (Fall 2023 update).”}