The US Department of Treasury and the Internal Revenue Service released anticipated final regulations pertaining to the federal income tax credit for carbon capture projects under Section 45Q of the Internal Revenue Code on January 6, 2021. The final regulations in certain significant respects respond favorably to taxpayer comments to the proposed regulations released on May 28, 2020.
Section 45Q of the Internal Revenue Code of 1986, as amended, provides a performance-based tax credit with respect to the disposal or utilization of qualified carbon oxide using carbon capture equipment at a qualified facility. Congress originally enacted the Section 45Q credit in 2008, but more recently extended and expanded the credit under the Bipartisan Budget Act of 2018, PL 115-123.
Section 45Q currently provides a tax credit in a specified dollar amount per metric ton of carbon oxide stored, depending on the applicable project type. Specifically, eligibility for and the amount of the Section 45Q credit depend on whether the captured qualified carbon oxide is disposed solely through secure geological storage (Disposal), used for tertiary injection and disposal through secure geological storage (Injection), or utilized in a manner described in Section 45Q(f)(5) (Utilization).
For currently in-development and future carbon capture equipment projects, the Section 45Q tax credit applies for the 12-year period following the project’s placed-in-service date. The tax credit dollar amount during this period escalates on a yearly basis until 2026, when it reaches either $35 or $50 per metric ton of carbon oxide stored (depending on the type of project), and for subsequent years may increase based on an adjustment for inflation. Only eligible qualified facilities the construction of which begins before January 1, 2026, and related carbon capture equipment that has either similarly begun construction before January 1, 2026, or the original planning and design for the applicable qualified facility includes installation of the carbon capture equipment, are eligible for the credit (with such eligibility dates recently extended from January 1, 2024, pursuant to the Consolidated Appropriations Act, 2021, described in our prior LawFlash).
For additional background and context on recent Section 45Q guidance, please also see our prior LawFlashes on the release of the proposed regulations, as well as the Internal Revenue Service’s (IRS’s) release of Notice 2020-12 (which provided guidance on satisfying the Start Construction Rule to qualify for the Section 45Q tax credit) and Revenue Procedure 2020-12 (which provided a safe harbor for tax equity investments using a “flip” partnership structure).
Some of the final regulations’ more significant refinements to or departures from the prior proposed regulations include the following:
The final regulations under Section 45Q should be relatively welcome to the carbon capture and storage industry in providing additional clarity to the standards, and relief from some of the more restrictive provisions, of the proposed regulations.
Principally, the final regulations reduce the five-year post-credit recapture period of the proposed regulations to three years. The prior five-year recapture period had been viewed by the industry as a significant impediment to attracting investment in projects generating Section 45Q credits (e.g., by “tax equity investors”), as many potential investors resisted accepting risk on this extended recapture period at the cost of capital being considered to make these investments economically viable. Hopefully, the reduction in investor risk associated with this shorter recapture period (perhaps also reflected in the reduced cost of tax insurance policies to cover this risk) will help spur investment in carbon capture facilities.
The final regulations do not, however, provide certainty for claiming the Section 45Q credit in all circumstances. Significantly, the final regulations do not provide eligibility guidance that taxpayers can prospectively rely on to support satisfying the “other purpose for which a commercial market exists” standard for Utilization. The final regulations require that the method used by the taxpayer be submitted with the tax return claiming the credit, and the preamble explicitly declined to address whether particular factual situations would be eligible. As a result, taxpayers seeking to qualify for this type of Utilization have no assurance that their constructed carbon capture facilities will qualify for the credit. Hopefully forthcoming guidance will provide specific examples of activities or factual situations that will satisfy this test. Similarly, the final regulations retain the proposed regulations’ requirement that a taxpayer’s lifecycle analysis to claim the Section 45Q credit for Utilization be approved before claiming the credit.
Finally, the continued vitality of the final regulations is not entirely free from doubt as of the date of this publication. The final regulations provide for an expedited effective date as of their filing in the Federal Register. And, President-elect Joseph Biden has indicated that released administrative regulations not yet published in the Federal Register or effective by January 20, 2021, may be subject to a delayed effectiveness or withdrawal pending further review. We do note, however, that President-elect Biden has in the past expressed support for the carbon capture and storage industry and the Section 45Q credit, such that withdrawal or delay of the final regulations if not published in the Federal Register or otherwise effective by January 20, 2021, is not certain.
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Morgan Lewis has experience representing clients in industries touching the Section 45Q tax credit, as well as representing sponsors, tax equity investors, and lenders in project financings subject to rules analogous to Section 45Q and associated government guidance, such as renewable energy project financings.
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