United States: IRS Releases Section 45Q Carbon Capture Tax Credit Guidance Regarding Qualifying Equipment Ownership

The IRS published today Revenue Ruling 2021-13 to clarify eligibility for the section 45Q federal tax credit for carbon capture and sequestration. The ruling provides much-needed guidance with respect to certain questions raised following release of the final regulations under section 45Q in January, as described in our prior alert here.

Rev. Rul. 2021-13 describes a fact set presenting questions of qualifying ownership of carbon capture equipment and then rules that, on the facts presented, the owner qualifies for the section 45Q tax credit. The ruling describes a syngas facility that includes an acid gas removal (AGR) unit that removes carbon dioxide from the syngas stream, after which the carbon dioxide can be either released into the atmosphere or captured. Under the facts described in the ruling, the AGR unit was placed in service in 2017 and, until 2021, released the captured carbon dioxide into the atmosphere. In 2021, an investor purchased and installed additional components of carbon capture equipment necessary to create a single process train capable of capturing, processing and transporting the carbon dioxide that previously was being released into the atmosphere. The investor did not, however, acquire an ownership interest in the syngas facility or the AGR unit.

On these facts, the ruling states that:

• The AGR unit is carbon capture equipment for purposes of section 45Q. Although the AGR unit also performs other functions, such as the removal of impurities and other gases, and even though the carbon dioxide has been emitted following treatment in the AGR unit, because one  of the unit's functions is to separate carbon dioxide from a gas stream, it is considered to be carbon capture equipment for purposes of section 45Q.
• The credit can be attributed to the investor, even though the investor does not own the AGR unit, because all components of carbon capture equipment within a single process train are not required to be owned by the same taxpayer. Although the regulations provide that there can be only one taxpayer to whom the credit is attributable per single process train of carbon capture equipment, such taxpayer need not own all  components of that process train. The ruling carries this principle to its logical conclusion by stating: “to be the person to whom the section 45Q credit is attributable, a person must own at least one component of carbon capture equipment in the single process train” (as well as either physically or contractually ensure the capture and disposal, injection or utilization of the carbon oxide).
• Even though the AGR unit is ruled to be “carbon capture equipment,” the fact that it was placed in service in 2017 does not change the 2021 placed-in-service date of the process train for purposes of section 45Q. The credit period under section 45Q is the 12-year period beginning on the date the carbon capture equipment is placed in service and the regulations provide that all components that make up an independently functioning process train capable of capturing, processing, and preparing carbon oxide for transport are to be treated as one unit of carbon capture equipment. Therefore, under the facts of the ruling, the relevant placed-in-service date for purposes of section 45Q is the placed-in-service date of the single process train which was completed upon the addition of the new components in 2021, allowing the carbon dioxide to be captured, processed and prepared for transport, disposal, injection or utilization, rather than released into the atmosphere.
• For depreciation purposes the single process train consists of two separate assets: the AGR unit that was placed in service in 2017, which retains it placed-in-service date for depreciation purposes under sections 167 and 168, and the new carbon capture equipment components purchased and installed in 2021 by the investor to complete the single process train, which have a 2021 placed-in-service date.

The ruling provides important authority on which an investor in carbon capture projects can rely to claim the section 45Q tax credit even though the investor may not take ownership of any part of the carbon dioxide-emitting industrial facility. Although the ruling describes an AGR unit, many industrial facilities emitting carbon dioxide today have a similar unit that separates the carbon dioxide from other gases or products of the industrial facility. Investors have been concerned that although such separation units could be interpreted as falling within the definition of “carbon capture equipment,” it might not be practical or possible to acquire an ownership interest in such units as part of the investment in the carbon capture process train, and they have therefore been worried that failure to own separation units would preclude them from eligibility for the credit. This ruling should put those concerns to rest.

Although not directly addressed, the ruling implicitly also resolves questions that had been raised regarding the application of the “80/20 rule.” The 80/20 rule, contained in Treas. Reg. section 1.45Q-2(g)(5), allows a qualified facility or carbon capture equipment to qualify as originally placed in service, even though some components are used property, if the fair market value of the used property is not more than 20 percent of the facility's total value. If the AGR unit described in the ruling is carbon capture equipment placed in service in 2017 and therefore considered “used” property for purposes of this analysis, the new equipment would have had to satisfy that rule in order to have the process train treated as placed in service in 2021. The ruling did not apply the 80/20 rule, however, implicitly indicating that the rule applies only when the used property was part of an independently functioning carbon capture process train, which was not the case on the facts of the ruling.

The ruling does not speak to the proper claimant of the credit as between the owner of the AGR unit and the investor in the new carbon capture equipment. Because the ruling clarifies that the AGR unit is carbon capture equipment and a credit claimant must own a single component within the process train, either the owner of the AGR unit or the investor is presumably eligible to claim the credit (provided that they also either physically or contractually ensure disposal, injection, or utilization). Since the regulations specify that there can be only one single claimant for any independently functioning carbon capture process train, in cases in which more than one party owns a component of the carbon capture process train and is therefore an eligible claimant, a question may arise as to the proper claimant. The ruling does not provide guidance on that question.

Finally, by stating for the first time with respect to section 45Q eligibility that a taxpayer must own “at least one component” of carbon capture equipment in the single process train, questions will now inevitably arise as to the sufficiency of the single component that a claimant might own, whether measured by size, cost or importance of function. Conservative investors, such as those in the tax equity market, are unlikely to push the envelope on this point, however.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.