Companies seeking tax credits in return for using technology to capture carbon dioxide now have two sure routes to knowing when the IRS thinks their projects actually started—and when they qualify for the tax benefit.
Investors spent two years waiting for Wednesday’s guidance, which was needed after lawmakers expanded the credit for carbon capture and sequestration under tax code Section 45Q. Some projects stalled during that time.
Time is of the essence: Construction on the projects must start before 2024 to qualify for the credit, and the expansion is effective for tax years that start during the 2018 calendar year.
The guidance touched on two of the industry’s top priorities, but left thornier issues for future regulations—such as which uses of sequestered carbon are eligible, said Hunter Johnston, a partner at Steptoe & Johnson LLP, who lobbied Congress on the credit on behalf of Peabody Energy and Lake Charles Methanol as recently as the fourth quarter of last year. Johnson said he expects more guidance within the next month.
“It’s consistent with expectations,” he said, adding that it’s built upon already existing guidance for other renewable energy credits. “It’s essential guidance, but not comprehensive.”
Companies must begin the “physical work” of a carbon-capture project, such as making turbines, pumps, cooling towers, and piping, or start work on-site for construction to officially have begun, the agency said in Notice 2020-12. Excavation to change the contour of the land doesn’t count, nor do “preliminary activities” like securing financing, conducting research, getting licenses and permits, exploring, and test-drilling, the IRS said.
There’s a second option: If a company already spent 5% of the project’s total cost, the IRS will view construction as having started, and therefore the project is eligible for the credit. But if the overall cost of the project is larger than expected, and that initial cost ends up being smaller than 5%, the company may flunk the safe harbor.
For both routes to eligibility, work on the project must be continuous, meaning the companies can’t start construction and then walk away and still get the credit.
Under similar guidance for other renewable energy projects, as part of that continuity mandate, projects must be completed and operational within four years of the start of construction to qualify for this kind of safe harbor or pass the physical work test. Shell, the Basin Electric Power Cooperative, the Carbon Capture Coalition, and others requested that the IRS extend that period to six years for the carbon capture credit—something the agency did in Wednesday’s guidance.
“We are especially pleased that the IRS has embraced our recommendation to provide for a longer six-year continuity requirement to complete construction of carbon capture projects,” the Carbon Capture Coalition said in a statement. “Nevertheless, this work took far too long and has delayed hundreds of millions, if not billions of dollars in investments in the development and deployment of carbon capture, use and geologic storage projects.”
In a revenue procedure also released Wednesday, the IRS laid out what firms financing the projects would have to do to receive some of the credit. Those investors would have to maintain a minimum investment of 20% of the certain capital investments for as long as they are partners in the projects in order to be guaranteed the credit or a cash equivalent.
The partners also can’t be protected from the potential loss of that minimum investment through some arrangement with the other parties involved in the project, such as the entity emitting the carbon, or the project developer, the IRS said.
The IRS also said it wouldn’t be issuing letter rulings—or statements of certain tax treatment of a transaction that are specific to the taxpayers that request them—on whether investor partners qualify for the credit.
Both pieces of guidance will be effective March 9. If construction began before then, the IRS will treat that date as the date construction began, according to the notice. If developers, investors, and project companies satisfied the revenue procedure prior to that date, the IRS will view the financiers as eligible for the portions of the credit they were allocated for those tax years.
Using a later construction start date under the guidance may come in handy meeting completion deadlines for projects already in the works, but there may be few such projects, said Brad Crabtree, vice president of carbon management at the Great Plains Institute, a nonprofit, and director of the Carbon Capture Coalition. The coalition is backing a House proposal to extend the expanded credit’s 2024 deadline for starting construction.
“You need that long planning investment horizon,” Crabtree said. “That’s really our top priority right now.”