Clean Economy Tax Credits: Clean Technology Investment Tax Credit As Updated By 2023 Fall Economic Statement And Bill C-59 - Environmental Law

On November 21, 2023, the 2023 Fall Economic Statement (Fall Economic Statement) was tabled in the House of Commons. The Fall Economic Statement can be found here. The Fall Economic Statement provided notable updates to the design and delivery of the Canadian clean economy investment tax credits, including the Clean Technology Investment Tax Credit (CT ITC) and the labour requirements (Labour Requirements) that must be satisfied to maximize the CT ITC, the Investment Tax Credit for Carbon Capture, Utilization and Storage (CCUS ITC), the proposed Investment Tax Credit for Clean Hydrogen (CH ITC) and the proposed Clean Electricity Investment Tax Credit (CE ITC).

On November 30, 2023, Bill C-59 received first reading in the House of Commons and the Department of Finance (Finance) released detailed explanatory notes (Explanatory Notes). Bill C-59 can be found here and the related Explanatory Notes can be found here. Among other tax measures, Bill C-59 will enact the CT ITC, the CCUS ITC and the Labour Requirements.

The CH ITC and Clean Technology Manufacturing Investment Tax Credit (CTM ITC) were announced in Budget 2023 and draft legislative proposals to implement these credits were released on December 20, 2023 (December 20 Proposals) which can be found here. The CE ITC was also announced in Budget 2023 but no draft legislation relating to this credit has been released.

This article reviews the CT ITC. Our review of the CCUS ITC can be found here and our review of the Labour Requirements can be found here. We will prepare a review of the CH ITC and CTM ITC.

All statutory references are to the Income Tax Act (Canada) (Tax Act) as amended by Bill C-59.

Background

In its 2022 Fall Economic Statement, the Government announced that it would introduce the CT ITC as a 30% refundable tax credit applicable to investments in eligible property that are acquired and become available for use on or after March 28, 2023.

Budget 2023 announced that the CT ITC would apply to certain additional property and that the phase-out rules would be modified.

On August 4, 2023, the Government released draft legislation (August 4 Proposals) to implement the CT ITC. Our commentary on the August 4 Proposals can be found here. Notably, the explanatory notes to the August 4 Proposals included a statement that the CT ITC rules "are generally intended to apply to partnerships and their partners that are taxable Canadian corporations in the same manner as the investment tax credits under section 127." As described in more detail below, the Government did not follow through on this statement and Bill C-59 includes rules for partnerships and their partners that are a significant departure from the existing rules in section 127.

The Fall Economic Statement proposed to expand the property eligible for the CT ITC to include property that generates electricity and/or heat from waste biomass. The Government indicated that it intends to begin consultations regarding this proposal in summer 2024 and to introduce legislation in the House of Commons in fall 2024.

Bill C-59 also includes further revisions to the provisions applicable to the CT ITC. We consider the main features of the CT ITC below.

Purpose

Consistent with Finance's recent practice to include statements of purpose to assist in the interpretation of legislative schemes, Bill C-59 states that the purpose of the CT ITC is "to encourage the investment of capital in the adoption and operation of clean technology property in Canada".

Qualifying Taxpayers

Only a "qualifying taxpayer" will be entitled to claim the CT ITC. While the August 4 Proposals defined "qualifying taxpayer" to mean a taxable Canadian corporation, Bill C-59 expands the definition to include a mutual fund trust that is a real estate investment trust as defined in subsection 122.2(1) (REIT). Bill C-59 also includes rules that apply to partnerships to enable a partner that is a qualifying taxpayer to claim its share of the CT ITC derived from expenditures made by the partnership to acquire clean technology property.

The definition of qualifying taxpayer reflects a policy choice to exclude, for example, individuals, tax-exempts and non-residents carrying on business through a branch in Canada from entitlement to the CT ITC.

Clean Technology Property

The CT ITC is available in respect of the cost of "clean technology property".

The types of property eligible for the credit are described in part by reference to classes of property described in Schedule II to the regulations under the Tax Act for capital cost allowance purposes. The following types of equipment are eligible:

equipment to generate electricity from solar, wind and water energy that is described in subparagraphs (d)(ii), (iii.1), (v), (vi) or (xiv) of Class 43.1;
stationary electricity storage equipment described in subparagraphs (d)(xviii) and (d)(xix) of Class 43.1, that does not use any fossil fuels in operation;
active solar heating equipment, air-source heat pumps, and ground-source heat pumps that are described in subparagraph (d)(i) of Class 43.1;
non-road zero-emission vehicles described in Class 56 (e.g., hydrogen or electric heavy duty equipment used in mining or construction) and charging or refuelling equipment described in subparagraph (d)(xxi) of Class 43.1 or subparagraph (b)(ii) of Class 43.2 that is used primarily for such vehicles;
equipment used exclusively for the purpose of generating electrical energy and/or heat energy, solely from geothermal energy, that is described in subparagraph (d)(vii) of Class 43.1, but excluding any equipment that is part of a system that extracts fossil fuel for sale;
"concentrated solar energy equipment" which is equipment, other than "excluded equipment", used all or substantially all to generate heat and/or electricity exclusively from concentrated sunlight. "Excluded equipment" is: auxiliary heating or electrical generating equipment that uses any fossil fuel; buildings or structures (other than those whose sole function is to support or house concentrated solar energy equipment); distribution equipment; property included in Class 10; and property that would be included in Class 17 read without reference to paragraph (a.1) thereof; or
a "small modular nuclear reactor", which is equipment that is used all or substantially all to generate electrical energy and/or heat energy from nuclear fission. It must be part of a system that has a gross rated generating capacity not exceeding 300 megawatts electric, or an energy balance equivalent gross rated generating capacity of electricity or heat equivalent of 1,000 megawatts thermal. All or substantially all of the system must be composed of modules that are factory-assembled and transported pre-built to the installation site. There are several specific exclusions (e.g., nuclear fission fuel).

In addition, the following requirements must be satisfied:

The property must be situated in Canada and intended for use exclusively in Canada. In the case of wind and water energy properties described in subparagraphs (d)(v) or (xiv) of Class 43.1, they may also be installed in Canada's exclusive economic zone as defined in the Oceans Act and Bill C-59 will make a corresponding amendment to subparagraph (e)(i) of Class 43.1.
The property must not have been used (or acquired for use or lease) for any purpose before it was acquired by the taxpayer. The credit is available only for new equipment.
If the property is to be leased by the taxpayer to another person or partnership, the lessee must be a qualifying taxpayer or a partnership all of the members of which are taxable Canadian corporations (i.e., a REIT may not be a member of a lessee partnership). The taxpayer must lease the property in the ordinary course of carrying on a business in Canada and the taxpayer's principal business must be selling or servicing property of that type, or must be leasing property, lending money, purchasing conditional sales contracts, accounts receivable, bills of sale, chattel mortgages or hypothecary claims on movables, bills of exchange or other obligations representing all or part of the sale price of merchandise or services, or any combination thereof.

For the purpose of determining whether a particular property is clean technology property, any technical guide published by the Department of Natural Resources, as amended from time to time, applies conclusively with respect to engineering and scientific matters.

Expanded Eligibility for Waste Biomass

The Fall Economic Statement proposes to expand the types of property eligible for the CT ITC to include property that supports the generation of electricity and heat from waste biomass comprising "specified waste materials" as defined in subsection 1104(13) of the Regulations). The CT ITC will only be available in respect of eligible waste biomass equipment that is acquired and becomes available for use on or after November 21, 2023, provided it has not been used for any purpose before its acquisition.

The CT ITC will apply to investments in eligible systems that use specified waste materials solely to generate electricity or both electricity and heat. Eligible systems must:

use feedstock which derives all or substantially all of its energy content (expressed as the higher heating value of the feedstock) from specified waste materials, as determined on an annual basis;
not use fuel that is not produced as an integrated part of the system (even if produced from specified waste material); and
not exceed a heat rate threshold of 11,000 British thermal units per kilowatt-hour.

The CT ITC will also apply to investments in eligible systems that use specified waste materials, other than spent pulping liquor, solely to generate heat energy. Eligible systems would be those that use feedstock, all or substantially all of the energy content (expressed as the higher heating value of the feedstock) of which is from specified waste materials (other than spent pulping liquor), as determined on an annual basis. Systems that use a fuel that is not produced as an integrated part of the system, even if produced from specified waste material, would not be eligible.

The Fall Economic Statement also proposes to replace rules in Classes 43.1 and 43.2 related to compliance with environmental laws, by-laws, and regulations. Currently, certain properties that would otherwise be eligible for inclusion in Class 43.1 or 43.2 are deemed not to be eligible if the taxpayer is not in compliance with environmental laws, by-laws and regulations at the time the property first becomes available for use. The Fall Economic Statement will replace these rules with a similar rule that looks only to significant non-compliance but will extend the application of the rule to all properties described in Class 43.1 or 43.2 and properties that would be eligible for the CT ITC and CE ITC.

Determining When Clean Technology Property is Acquired and its Capital Cost

The CT ITC of a qualifying taxpayer for a taxation year is the total of all amounts each of which is the specified percentage of the capital cost to the taxpayer of clean technology property acquired by the taxpayer in the year.

A clean technology property is deemed not to have been acquired by a taxpayer before the property is considered to have become "available for use" by the taxpayer for the purpose of claiming capital cost allowance except that this determination is to be made without regard to rules that deem a property to have become available for use immediately before it is disposed of by the taxpayer.

The rules provide for certain adjustments in determining the capital cost of clean technology property to a taxpayer for the purpose of claiming the CT ITC:

capital cost does not include any amount (i) for which a CT ITC was previously deducted by any person, (ii) in respect of which a CCUS ITC, CH ITC or CTM ITC was deducted by any person (it is possible that certain property otherwise eligible for the CT ITC may also be eligible for the CCUS ITC, CH ITC or CTM ITC), or (iii) that was added to the cost of a property under section 21 (which allows a taxpayer to capitalize certain interest payable on money borrowed to acquire depreciable property or on the unpaid balance of the purchase price of depreciable property);
if any part of the capital cost of a taxpayer's clean technology property is unpaid on the day that is 180 days after the end of the taxation year in which the CT ITC would otherwise be available in respect of the property, the unpaid amount is excluded from the capital cost of such property and instead is added to the capital cost of such property at the time the unpaid amount is paid;
capital cost is determined without reference to subsections 13(7.1) and (7.4) but is reduced by the amount of any "government assistance" or "non-government assistance" (each as defined in subsection 127(9)) that can reasonably be considered to be in respect of the property and that, at the time of the filing of the taxpayer's return of income under Part I of the Tax Act for the taxation year in which the property was acquired, the taxpayer received, is entitled to receive or can reasonably be expected to receive. The definition of "government assistance" in subsection 127(9) will be amended to exclude the CT ITC. If, in a particular taxation year, the taxpayer repays (or has not received and can no longer reasonably be expected to receive) government assistance or non-government assistance that reduced the capital cost of clean technology property, the amount repaid (or no longer expected to be received) is deemed to be added to the cost to the taxpayer of a property acquired in the particular year for the purpose of determining the taxpayer's CT ITC for the year; and
where property is acquired by the taxpayer from a person or partnership with which it does not deal at arm's length, the cost will generally be the lesser of the cost otherwise determined and the cost of the property to the supplier (so as to exclude any mark-up).

Amount of the CT ITC

The CT ITC is the specified percentage of the capital cost to the taxpayer of clean technology property acquired by the taxpayer in the year.

The specified percentage is 30% for property acquired and available for use from March 28, 2023 (after November 20, 2023 in the case of eligible waste biomass equipment) until December 31, 2033.

Property that becomes available for use in 2034 is eligible for only a 15% credit and no credit is available for property that becomes available for use after 2034.

However, as discussed in our blog on the Labour Requirements (available [here]), if the taxpayer does not elect to satisfy the Labour Requirements, the amount of the CT ITC will be reduced by 10%.

Claiming the CT ITC

To claim a CT ITC for a taxation year, a qualifying taxpayer must file a prescribed form with its income tax return for the year. If the prescribed form is not filed within one year of the filing due date for the taxation year, no CT ITC will be available for that year. Bill C-59 expressly provides that the Minister does not have the discretion under subsection 220(2.1) to waive the requirement.

If the qualifying taxpayer files the prescribed form as required, the taxpayer is deemed to have paid on its balance-due day for the year on account of its tax payable under Part I of the Tax Act for the year an amount equal to the taxpayer's CT ITC. To the extent that the CT ITC and any other refundable credits and instalment payments exceed the taxpayer's tax otherwise payable under Part I for the year, the taxpayer is entitled to a refund.

For certain provisions of the Tax Act that apply in relation to an amount deducted in computing tax payable (the CT ITC, paragraph 12(1)(t), subsection 13(7.1), the description of I in the definition undepreciated capital cost in subsection 13(21), and subsection 53(2)), an amount equal to the taxpayer's CT ITC is deemed to have been deducted from the taxpayer's tax otherwise payable under Part I of the Act.

A CT ITC claimed by the taxpayer in a taxation year in respect of the acquisition of a clean technology property in the taxation year will normally reduce the capital cost of the property in the following taxation year under paragraph 13(7.1)(e). However, if the property is disposed of before the CT ITC is claimed, the "undepreciated capital cost" (UCC) of the class in which the property was included will be reduced by the amount of the CT ITC for subsequent taxation years.

Partnerships

Only a qualifying taxpayer (i.e., a taxable Canadian corporation or a REIT) may claim the CT ITC.

However, the CT ITC may be claimed by a partner of a partnership in respect of the capital cost of a partnership's clean technology property if the partner is a qualifying taxpayer.

In general, where a CT ITC would be determined in respect of a partnership if the partnership were a taxable Canadian corporation (i.e., because the partnership acquired clean technology property) the portion of the amount of the CT ITC that can reasonably be considered to be a partner's share of the credit is added in computing the partner's CT ITC at the end of the particular year if the partner is a qualifying taxpayer. The amount so added will reduce the adjusted cost base of the partnership interest to the partner.

Bill C-59 adds new section 127.47 to address the allocation of "clean economy tax credits" by a partnership. Bill C-59 defines "clean economy tax credits" as the CT ITC and CCUS ITC but this definition will be expanded by the December 20 Proposals to include the CH ITC and CM Tax Credit. The provisions of section 127.47 will override the general rule described above where there is a conflict.

Subsection 127.47(2) provides that, where a partner's share of a clean economy tax credit is not reasonable in the circumstances having regard to the capital invested in or work performed for the partnership by the partners or such other factors as may be relevant, that share shall, notwithstanding any agreement, be deemed to be the amount that is reasonable in the circumstances (Reasonable Allocation Rule). In the August 4 Proposals, the Reasonable Allocation Rule was to be included in section 103.

Subsection 127.47(4) is a new apportionment rule which provides that the amount required by any clean economy allocation provision (i.e., currently the rules relating to the CT ITC and CCUS ITC) to be added in computing a particular clean economy tax credit of a taxpayer in respect of a partnership for the taxation year in which the partnership's fiscal period ends is deemed to be the portion of the amount otherwise determined under section 127.47 in respect of the taxpayer that is reasonably attributable to each particular clean economy tax credit. This rule appears to prevent streaming of particular types of credit to different partners. The examples in the Explanatory Notes indicate that allocating credits based on the proportion of qualifying expenditures or credit amounts may be reasonable in the circumstances.

In the August 4 Proposals, it was not clear whether the capital cost of property acquired by the partnership would be reduced by CT ITCs claimed by the partners. In particular, subsection 127(12), which was intended to achieve the former reduction under subsection 13(7.1) for investment tax credits, was not made applicable to the CT ITC. Subsection 127.47(6) provides that amounts added to a partner's CT ITCs are deemed to be government assistance received by the partnership at the end of the partnership's fiscal year which reduces the partnership's undepreciated capital cost balance for the related eligible property.

Limited Partnerships

In the August 4 Proposals, subsections 127(8.1) to (8.5) were to apply to determine the amount of CT ITCs generated by expenditures of a limited partnership to be allocated to the partners with such modifications as the circumstances require. These rules are complex but, in brief, the amount of the CT ITC that could be allocated to a particular limited partner was limited to the lesser of (i) the amount of the CT ITC considered to arise because of the expenditure of the limited partner's "expenditure base" (as defined in subsection 127(8.2)), and (ii) the limited partner's "at-risk amount" (as determined under subsection 96(2.2)) at the end of the particular fiscal period. Where CT ITCs could not be allocated to limited partners due to these restrictions, the unallocated credit amount was deemed by subsection 127(8.3) to be added to the reasonable share of the general partners. The reference to subsections 127(8.1) to (8.5) was removed in Bill C-59.

Instead, Bill C-59 makes a relieving change relative to amount of tax credits that can be allocated to a limited partner. Subsection 127.47(3) provides that, if a taxpayer is a limited partner of a partnership at the end of a fiscal period of the partnership, the total of all "clean economy tax credits" allocated to the taxpayer by the partnership in respect of that fiscal period shall not exceed the taxpayer's at-risk amount in respect of the partnership at the end of that fiscal period. The second limitation in the August 4 Proposals related to expenditure base has been deleted. The at-risk amount limitation in subsection 127.47(3) "trumps" the allocation under the Reasonable Allocation Rule. Bill C-59 does not include a rule analogous to subsection 127(8.3) deeming the amount by which a limited partner's reasonable share is reduced to be the reasonable share of the general partner.

Bill C-59 also provides a look-through rule applicable to tiered partnerships.

An example in the Explanatory Notes relating to new subsection 127.47(7) applicable to tiered partnerships contemplates that a general partner can be allocated CT ITCs that arise from qualifying expenditures financed with money borrowed by the limited partnership.

Tax Shelters and Tax Shelter Investments

If a clean technology property in respect of which the taxpayer is otherwise eligible to claim the CT ITC, or any interest in a person or partnership with a direct or indirect interest in such property, is a "tax shelter investment" for the purpose of section 143.2, the CT ITC is denied in respect of the property. This may be contrasted with the analogous rule in the context of the CCUS ITC which would deny the CCUS ITC in respect of a qualified CCUS project where any property used in the qualified CCUS project, or any interest in a person or partnership with a direct or indirect interest in any property used in the qualified CCUS project, is a tax shelter investment.

Note that all investments that are "tax shelters" as defined in section 237.1 are included within the tax shelter investment definition.

Recapture of the CT ITC

In certain circumstances, some or all of the CT ITC claimed by a taxpayer may be recaptured.

Recapture will occur in relation to a particular clean technology property of a taxpayer in a taxation year if the following conditions (Recapture Conditions) are satisfied:

the taxpayer acquired the property in the year or in any of the preceding 10 calendar years (note that Bill C-59 reduces the recapture period to 10 calendar years from 20 calendar years as was provided in the August 4 Proposals);
the taxpayer became entitled to a CT ITC in respect of all or a portion of the capital cost of the property; and
in the year, the particular property is (i) converted to a "non-clean technology use" (i.e., would not be clean technology property if acquired at the particular time, disregarding the new equipment requirement), (ii) exported from Canada, or (iii) disposed of without having previously been converted to a non-clean technology use or exported (i.e., disposed of without having previously been subject to recapture).

Recapture will not be triggered on the disposition of a property by a taxable Canadian corporation (the transferor) to another taxable Canadian corporation (the transferee) that is "related" to the transferor if the property would be clean technology property to the transferee disregarding the new equipment requirement. This rule (Related Transfer Rule) facilitates transfers of clean technology property within a corporate group. Bill C-59 expressly provides that the Related Transfer Rule only applies if the transferor and transferee are both taxable Canadian corporations and that it does not apply to a REIT. If this rule applies, subsection 127(34) is to apply "with such modifications as the circumstances require". The intention appears to be to put the transferee in the same position as if it had originally acquired the property and claimed the CT ITC for the purposes of applying the recapture rules. We observe that the circumstances would appear to require substantial modifications to subsections 127(34) for the purpose of applying it to the CT ITC.

Bill C-59 introduces a reporting requirement which requires a taxpayer to notify the Minister in prescribed form no later than the taxpayer's filing due date for a taxation year in which the Recapture Conditions are satisfied or the Related Transfer Rule applies.

Recapture is effected by adding an amount to the taxpayer's tax otherwise payable under Part I for the year. In the case of an arm's length disposition of the property, the amount is determined by multiplying the CT ITC in respect of the property by a fraction, the numerator of which is the proceeds of disposition and the denominator of which is the capital cost of the property. In any other case (conversion to non-clean technology use, export or a disposition other than to a person that deals at arm's length), the numerator of the fraction is the fair market value of the property, presumably at the time of the triggering event but that is not stated (unlike the analogous partnership rule described below which expressly provides that the relevant time is the time of the triggering event). In no case will the amount added to the taxpayer's tax otherwise payable under Part I exceed the CT ITC in respect of the property.

A recapture mechanism is also provided for clean technology property owned by a partnership. The August 4 Proposals incorporated by reference the recapture rules under subsections 127(28) to (31) applicable to the cost of property that was eligible for SR&ED. However, Bill C-59 introduces specific recapture provisions for the CT ITC. The mechanism will apply if the Recapture Conditions are satisfied determined as if the partnership were a taxpayer. The amount of recapture, determined substantially as described in the preceding paragraph, will be allocated to the partners of the partnership (including deemed partners under the look-through rule for tiered partnerships) and included in computing their tax payable under Part I of the Tax Act for the taxation year in which the fiscal period of the partnership ends. The adjusted cost base of the partners' partnership interests will be correspondingly increased. Bill C-59 also introduces a reporting requirement which requires a partnership that is subject to recapture to notify the Minister in prescribed form no later than the filing due date for partnership's partnership information return in respect of the period.

Interaction with the CE ITC

With respect to the potential overlap between the CT ITC and the CE ITC we expect particulars will be announced by the Government in 2024. In particular, the 2023 Fall Economic Statement indicated that, for taxpayers other than publicly-owned utilities, details regarding the CE ITC will be published in early 2024 and consultations regarding draft legislation will be launched in summer 2024. For publicly-owned utilities, consultations with provinces and territories will be launched in 2024. The Government intends to introduce legislation in the House of Commons in fall 2024.

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Canada: Clean Economy Tax Credits: Clean Technology Investment Tax Credit As Updated By 2023 Fall Economic Statement And Bill C-59