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October 23, 2024 Canada issues proposed legislation for new clean electricity investment tax credit
Draft legislative proposals for the introduction of Canada's clean electricity investment tax credit (ITC), which was first announced in the 2023 federal budget,1 were released for public consultation on 12 August 2024.2 The new 15% refundable tax credit is intended to support "clean electricity technologies and proponents" to expand the capacity of Canada's clean electricity grid to accelerate progress toward a net-zero grid. This Tax Alert provides an overview of the proposed legislation, including the key design features included in proposed section 127.491 of the Income Tax Act (the Act), which are generally consistent with the design features included in the 2024 federal budget,3 and the associated labor requirements included in section 127.46 of the Act. The proposals described below may undergo further amendments before they are tabled in a bill. Overview of the clean electricity ITC The clean electricity ITC legislative proposals are designed to encourage the investment of capital in the deployment of clean electricity property in Canada, as noted in proposed subsection 127.491(38). The ITC will be available to qualifying entities that make eligible investments in clean electricity property on or after 16 April 2024 and before 1 January 2035, provided that the property is not part of a construction project that began before 28 March 2023. A 15% tax credit is available in respect of the capital cost of certain eligible equipment that qualifies as clean electricity property. The ITC rate may be reduced by 10 percentage points if certain labor requirements are not met (see "Labor requirements," below). Eligible equipment will include properties primarily used for the generation of clean electricity. The draft legislative proposals provide a clear definition and set the standards for what constitutes clean electricity property, including environmental compliance and emission intensity thresholds. Although the clean electricity ITC rules are similar to the rules for the clean technology ITC4 from a technical perspective, there are key differences with respect to the credit rate, eligible properties and eligible credit recipients. The clean electricity ITC may be claimed in addition to the Atlantic ITC, but generally not in combination with any other federal ITC. Qualifying entity While many of the clean economy ITCs focus mainly on taxable Canadian corporations, including those that are members of partnerships, the legislative proposals for the clean electricity ITC also extend to qualifying trusts and eligible investments made by designated provincial Crown corporations5 and corporations owned by Canadian municipalities or Indigenous governing bodies. A "qualifying entity" as it relates to the clean electricity ITC means a qualifying corporation or qualifying trust, as defined in proposed subsection 127.491(1). In addition, pursuant to proposed subsection 127.491(13), qualifying entities that are members of a partnership that acquires eligible property may also qualify for the clean electricity ITC. A qualifying corporation includes:
To be a qualifying trust, the trust must, at all relevant times, satisfy the following three conditions:
Clean electricity property To qualify for the clean electricity ITC, an investment must be made for eligible equipment that qualifies as clean electricity property. The draft legislative proposals define what constitutes clean electricity property (proposed subsection 127.491(1)). Of the property types within the definition, many share eligibility with property included in the clean technology ITC,6 while others are unique to the clean electricity ITC (e.g., qualified natural gas energy equipment). Types of eligible equipment include:
The eligible equipment described above must also generally meet the following conditions to qualify as clean electricity property that is eligible for the ITC:
A property that would otherwise qualify as clean electricity property will be deemed to be ineligible if, at the time the property becomes available for use, the entity is in substantial noncompliance with the requirements of any environmental law, bylaw or regulation of Canada, a province, a municipality, or a municipal or public body performing a governmental function in Canada that is applicable in respect of the property. A similar requirement applies for purposes of the clean technology ITC. The Department of Natural Resources has the final authority on engineering and scientific matters concerning the eligibility of a property as clean electricity property. Any technical guide published by the Department of Natural Resources, including periodic updates, is to apply conclusively for the purpose of determining whether a property is a clean electricity property. Clean electricity ITC rates Qualifying clean electricity property is eligible for the ITC at a rate of 15% for property acquired on or after 16 April 2024 and before 1 January 2035. Designated provincial Crown corporations located in areas that were not recognized as eligible jurisdictions by the Minister on or before 31 March 2025 are not eligible for the clean electricity ITC for any property acquired prior to the date when their jurisdiction is designated as eligible. Similar to other clean economy ITCs included in section 127 of the Act, property is deemed to have been acquired by the taxpayer when the property becomes available for use. However, this deeming rule is not applicable for property acquired before 16 April 2024. The rate could be reduced by 10 percentage points if the claimant does not elect to meet the labor requirements set out in section 127.46 of the Act; these requirements are detailed further in the "Labor Requirements" section below. Calculating the ITC base The capital-cost base on which the ITC is calculated must be reduced for any property for which any of the clean economy tax credits, as defined under section 127.47(1), were deducted. More specifically, in addition to the clean electricity ITC, the other clean economy tax credits are:
When a taxpayer has received assistance, whether from government or non-government organizations, the ITC is calculated on the cost base of the equipment net of any financial assistance received. If the assistance is subsequently repaid or the taxpayer is no longer eligible for the assistance, the amount by which the cost of the property was reduced is added back to the capital cost of the property for the purpose of calculating the ITC. Because a property must be acquired in the year to obtain an ITC (as required under the definition of "clean electricity investment tax credit" in proposed subsection 127.491(1)), a separate property is deemed to have been acquired to enable the ITC to be claimed in respect of the later year. If a portion of the cost of the property capitalized remains unpaid after 180 days from the end of the fiscal year in which the property became available for use, the capital cost of the property must be reduced by the unpaid amount. This amount can later be added back to the capital cost upon payment of the outstanding balance. Proposed subsection 127.491(10) lists other exclusions and rules applicable in computing the capital cost of clean electricity property. In particular, expenditures related to preliminary work activities cannot be included in the capital cost of clean energy property pursuant to proposed subparagraph 127.491(10)(a)(v). Broadly speaking, a preliminary work activity (defined in proposed subsection 127.45(1)) is an activity that is preliminary to the acquisition, construction, fabrication or installation by or on behalf of a taxpayer of eligible property. Time limit for ITC application Proposed subsection 127.491(7) places a time limit on filing the prescribed form necessary to be eligible for the clean electricity ITC. Specifically, the prescribed form must be filed on or before the day that is one year after the taxpayer's filing due date for the year. Recapture of credit The recapture of the credit will apply if the property is converted to an ineligible use, disposed of or exported from Canada within 10 calendar years of the date it was acquired; however, if the clean electricity property is qualified natural gas energy equipment, the recapture period is 20 years. The amount of the credit repayable is calculated using a specific formula that takes into account (1) the amount of the taxpayer's clean electricity ITC for the property (less any amount previously paid by the taxpayer for recovery related to a qualified natural gas energy system in respect of the property7), (2) the proceeds of disposition of the property or its fair market value (if the property is disposed of to a non-arm's-length party, converted to an ineligible use or exported), and (3) the capital cost of the particular property on which the clean electricity ITC was deducted. For partnerships, recapture rules apply as if the partnership were a taxable Canadian corporation. The amount of tax determined because of recapture in respect of the partnership is added to the tax payable of the partnership members for the tax year. An election is available to allow a member of a partnership to elect to pay the total amount of recapture or recovery tax that would otherwise have to be allocated to each member of the partnership for payment. Proposed subsection 127.491(24) provides for a deferral of the recapture if clean electricity property is transferred to a related qualifying entity where certain conditions are met. This relieving provision is intended to facilitate bona fide transfers of clean electricity property within corporate groups. Taxpayers are required to notify the Minister in prescribed form and manner if the recapture rules apply, or the recapture is deferred as a result of the related party relief, on or before the taxpayer's filing due date for that year. A note on partnerships Section 127.47 of the Act provides rules that apply to partnerships with respect to certain clean economy ITCs, including rules regarding the allocation of ITCs from a partnership to its members. The draft legislative proposals released on 12 August 2024 include proposed subsection 127.47(4.1) of the Act, which provides rules to clarify the amount that a taxpayer who is a member of a partnership is deemed to have paid on account of its tax payable under Part I of the Act under each of the clean economy tax credits. A qualifying taxpayer is generally restricted to claiming one of the clean economy tax credits if the property is eligible for more than one clean economy tax credit. If property is eligible for more than one clean economy ITC, a qualifying taxpayer is generally limited to one of the tax credits on the cost of the property. Proposed subsection 127.47(4.1) generally provides that if property is owned at the partnership level, each member of the partnership may generally claim any one — but not more than one — credit that they have been allocated by a partnership. The rules provide an exception to ensure that the dual-use equipment rules in the CCUS and clean hydrogen ITC context still allow each portion of the property to support a credit claim. The Finance Explanatory Notes provide an example of this rule. In the scenario provided, Partner A and Partner B are limited partners of a limited partnership and Partner C is the general partner. All three partners are taxable Canadian corporations. Partner A and Partner B have each made a CA$10,000 contribution to the partnership. The partnership acquires a CA$20,000 property that qualifies as both clean electricity property and clean technology property. The clean electricity and clean technology ITC are calculated at the partnership level, as if the partnership were a taxable Canadian corporation. At the partnership level, the notional clean electricity ITC on this property is CA$3,000 (assuming a specified percentage of 15%) and the notional clean technology ITC is CA$6,000 (assuming a specified percentage of 30%). Due to making equal partnership contributions, Partner A and Partner B each has a 50% share of these ITCs. Partner A can decide if it wants to claim its CA$1,500 share of the clean electricity ITC or its CA$3,000 share of the clean technology ITC, unless Partner A is ineligible for either of the ITCs. Partner B can also decide which of the ITCs it wants to claim, regardless of which ITCs Partner A has chosen to claim, provided that Partner B is eligible for both ITCs. The partnership will be deemed to have received the amount of the ITC claimed by each partner for the purposes of subsection 13(7.1) of the Act. This rule is important in partnerships that are composed of entities that do not qualify for the clean technology ITC but do qualify for the clean electricity ITC. Labor requirements As detailed below, the 15% refundable ITC rate could be reduced by 10 percentage points if the claimant does not elect to meet the labor requirements set out in section 127.46 of the Act. To meet the labor requirements, the ITC claimant must elect in prescribed form and manner for each installation tax year (i.e., a tax year during which preparation or installation of the clean electricity property occurs). The reduced ITC rate will automatically apply in situations where the taxpayer has not elected in the prescribed manner to meet the prevailing wage and apprenticeship requirements for an installation tax year. Prevailing wage requirements The taxpayer must meet the following labor requirements to qualify for the full incentive:
For these purposes, a covered worker means an individual:
Apprenticeship requirements In addition to the prevailing wage requirements set out above, the ITC claimant must make reasonable efforts to ensure that apprentices registered in a Red Seal trade8 work at least 10% of the total work performed by Red Seal workers on the installation of the clean electricity property. If a labor law or other agreement restricts the use of apprentices, then the ITC claimant must make every effort to ensure the highest percentage of labor hours is achieved. In addition, the ITC claimant must attest in prescribed form and manner that it has met the apprenticeship requirements in respect of covered workers at the designated work site. Subsection 127.46(16) provides specific steps that require the ITC claimant to demonstrate that it is deemed to satisfy the reasonable efforts requirement noted above. According to the Finance Explanatory Notes, the steps are intended to be illustrative of a means of meeting the reasonable efforts tests, as such variations to take into account the ITC claimant's specific circumstances may also be considered reasonable efforts. Certain steps must be taken at least every four months during the installation year. These steps are mainly in respect of satisfying specific job posting requirements, communicating with the trade unions and various educational institutions, and confirming the availability of apprentices at designated work sites. The remaining steps require the ITC claimant to review and duly consider all applications received and to attest compliance of the requirements in prescribed form and manner. Penalties for noncompliance with labor requirements The legislation includes a penalty in the form of an additional tax amount payable when the taxpayer has claimed the ITC based on electing to satisfy the labor conditions but fails to meet the requirements. The penalty is calculated as CA$20 for every day a covered person was not paid the prevailing wage rate during the installation year and, with respect to the apprenticeship requirements, CA$50 for every hour the total apprenticeship time falls below the specified hours. The amounts used to calculate the penalty will be indexed to inflation after 2023. In addition, subsection 127.46(17) addresses the allocation of any additional tax or penalties imposed where the incentive claimant is a partnership. Gross negligence If the incentive claimant has claimed the regular ITC rate based on meeting the labor requirements and it is later determined that the claimant knowingly (or in circumstances amounting to gross negligence) did not satisfy the conditions, the taxpayer must pay back the portion of the incentive for which they were not eligible, plus a penalty equal to half of that ineligible amount. Corrective measure Upon receiving a notification from the Minister specifying that the claimant did not meet the prevailing wage requirement set out above, the claimant may comply with the requirements by provide a "top-up" amount, plus interest, to each covered worker for the shortfall in pay. The claimant must pay the top-up amount (including interest) within one year after receipt of the notification, unless the Canada Revenue Agency considers a longer period to be acceptable in the circumstances. The top-up amount would be considered salaries paid in the year and deductible from income tax purposes, but it will not qualify for the ITC. If the top-up amount is not paid to any particular covered worker, a penalty equal to 120% of the top-up amount will apply. Conclusion The clean electricity ITC, along with other previously legislated and proposed clean economy ITCs, is intended to help Canada transition to a clean economy by encouraging the investment of capital in the development of these projects in Canada. The public consultation period for the clean electricity ITC draft legislative proposals closed on 11 September 2024. As noted above, the proposals may undergo further amendments before they are tabled in a bill to take into account stakeholder feedback.
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