The U.S. Department of the Treasury and IRS recently issued final regulations regarding carbon capture tax credits under section 45Q of the Internal Revenue Code, which amend and clarify the proposed regulations issued last year.
For a description of the proposed regulations, see McGuireWoods’ June 2020 alert, “IRS Proposes Regulations for Carbon Capture Tax Credit. ” The IRS also issued other guidance with respect to the carbon capture tax credits in 2020. For an overview of Notice 2020-12 (the begin construction notice) and Revenue Procedure 2020-12 (flip safe harbor), see McGuireWoods’ February 2020 alert, “IRS Provides Carbon Capture Tax Credit Guidance and Safe Harbor.”
The Section 45Q credit is available for each metric ton of qualified carbon oxide that is captured using carbon capture equipment at a qualified facility and then used in commercial product (utilization), used as a tertiary injection in a qualified enhanced oil or natural gas recovery project (injection), or disposed of through secure geological formation (disposal). The amount of the tax credit increased in 2018 for projects placed in service on or after Feb. 9, 2018. The newly increased credit will reach $35 per metric ton when the captured carbon is injected or utilized and will reach $50 per metric ton when the captured carbon is disposed of in a secure geological formation. Those maximum credit amounts will apply to credits generated in tax years after 2026.
In the case of carbon capture equipment originally placed in service at a qualified facility on or after Feb. 9, 2018, the credit is available during the 12-year period beginning on the date the carbon capture equipment is placed in service, and such credit is generally available to the person who owns the carbon capture equipment and physically or contractually ensures the capture and disposal, injection or utilization of such carbon oxide. The construction of the facility that includes the carbon capture equipment must begin by the end of 2025 to qualify for the credits. The 2021 Consolidated Appropriations Act extended the original Dec. 31, 2023, beginning-of-construction deadline for qualified facilities and carbon capture equipment to Dec. 31, 2025.
The final regulations make a number of important clarifications and technical changes, including the following:
- Recapture Period. The proposed regulations included a five-year recapture period. The final regulations shortened the recapture period to three years because the three-year period sufficiently accounts for the risk of leakage and reduces the compliance burden that would be imposed by a five-year recapture period.
- Definition of Carbon Capture Equipment. The definition of “carbon capture equipment” in the proposed regulations included an expansive list of “qualifying carbon capture components” that would be considered carbon capture equipment and a list of “excluded components” that would not. The final regulations removed these lists in favor of a function-based definition. The final regulations provide that “carbon capture equipment” generally includes all components of property that are used to capture or process carbon oxide until the carbon oxide is transported for disposal, injection or utilization. The final regulations provide that carbon capture equipment generally does not include components of property used for transporting qualified carbon oxide for disposal, injection or utilization. However, the final regulations provide that carbon capture equipment includes a system of gathering and distribution lines that collect carbon oxide captured from a qualified facility or multiple qualified facilities that constitute a single project.
- Definition of Commercial Market for Utilization. The carbon capture credit applies to carbon oxide that is “utilized” in certain situations, including for “any other purpose for which a commercial market exists.” The proposed regulations did not define “commercial market.” The final regulations define existing commercial market broadly as a market in which a product, process or service that utilizes carbon oxide is sold or transacted on commercial terms.
- Binding Written Contract. The proposed regulations set forth certain contract provisions necessary for a contract ensuring the capture and disposal, injection or utilization of qualified carbon oxide to qualify as a “binding written contract.” The final regulations adopted the definition of “binding written contract” set forth in the Notice 2020-12 and in Treasury Regulation Section 1.168(k)-1(b)(4)(ii)(A)-(D).
- Transferability of Carbon Capture Credit. The proposed regulations provided guidance regarding who may make an election under section 45Q(f)(3)(B) to allow a third-party taxpayer that disposes, utilizes or injects the qualified carbon oxide to claim the credit. The final regulations clarify that the disposer, injector or utilizer that enters into the contract with the electing taxpayer for the disposal, injection or utilization of the electing taxpayer’s qualified carbon oxide is the party that may qualify as a credit claimant. If that disposer, injector or utilizer subcontracts with a third party, the subcontractor may not be a credit claimant.
- Amount of Carbon Oxide Utilized. The final regulations measure the amount of carbon oxide utilized by aggregating the full greenhouse gas life cycle (LCA). This includes all stages of product and feedstock production and distribution, from feedstock generation or extraction through the distribution and delivery of the finished product to the ultimate consumer. The taxpayer verifies the amount of qualified carbon oxide utilized through an LCA. The LCA report must be prepared in conformity with International Organization for Standardization (ISO) 14040:2006, Environmental management — Life cycle assessment — Requirements and guidelines.
- Aggregation of Multiple Facilities. The final regulations permit taxpayers to aggregate multiple carbon capture facilities to satisfy the minimum carbon oxide capture thresholds under aggregation rules similar to those in Notice 2020-12.
The final regulations provide additional clarity to developers and investors, which should spur investment in carbon capture projects.
McGuireWoods lawyers are experienced in energy, project finance and tax equity structures. Do not hesitate to reach out and discuss any of the above information.