Yesterday, Treasury and the IRS issued final regulations on the expanded carbon capture tax credit implementing a number of welcome changes and clarifications to the proposed regulations. Key changes are generally investor-favorable and include (i) simplifying the definition of carbon capture equipment; (ii) allowing smaller carbon capture facilities to be aggregated for purposes of meeting minimum capture requirements; (iii) reducing the tax credit recapture period to 3 years; and (iv) incorporating the recently enacted 2-year extension (from January 1, 2024 to January 1, 2026) for beginning construction on carbon capture projects. Providing much-needed certainty to investors, the final regulations should stimulate investment in carbon capture technology and projects.
Definition of Carbon Capture Equipment
The proposed regulations included a detailed definition of carbon capture equipment, including specific uses for qualifying equipment and a long list of included and excluded components. In response to numerous comments, the final regulations simplify the definition and add flexibility by removing the component lists. Instead, the final regulations define carbon capture equipment to include components necessary to compress, treat, process, liquefy pump or perform other physical actions to capture carbon oxide. As in the proposed regulations, property used for transporting qualified carbon oxide for disposal, injection, or utilization is generally excluded, except for gathering and distribution lines that collect carbon oxide captured from one or more qualified facilities that constitute a single project (as defined in the “beginning construction” rules in IRS Notice 2020-12) and transport the carbon oxide to a pipeline.
The final regulations also clarify that all components that make up an “independently functioning process train” constitute a single unit of carbon capture equipment. With respect to each process train, only one person (including a partnership) can claim the credit for each process train. The final regulations also use this unit of property definition in applying the 80/20 test to determine whether the enhanced post-2017 credit applies to a facility containing retrofitted equipment.
Aggregation of Captured Carbon Across Multiple Facilities
In an effort to encourage additional carbon capture, the final regulations permit the aggregation of smaller carbon capture facilities into one project (based on the application of a facts and circumstances test) for purposes of meeting certain minimum carbon oxide capture thresholds set forth in the statute. Commenters on the proposed regulations noted that numerous industrial facilities may be able to meet the minimum carbon oxide capture requirements, and, as a result, would be encouraged to capture carbon that is currently being vented into the atmosphere, if such aggregation were permitted. The final regulations adopt the suggestion that multiple facilities may be treated as a single facility if the “single project” factors set forth in IRS Notice 2020-12 are met.
IRS Notice 2020-12 permits treating multiple qualified facilities or units of carbon capture equipment that are operated as part of a single project (along with other property that serves some or all of the facilities) as a single project for beginning construction purposes. Factors included in the notice indicating that multiple qualified facilities comprise a single project include: common ownership, geographic proximity, a single system of gathering lines or take-off operation that collects and delivers carbon oxide to a pipeline, common environmental or regulatory permits or reporting, and common construction or financing.
Tax Credit Recapture Period
The proposed regulations included a 5-year period for which previously claimed tax credits were at risk for being recaptured in the event sequestered carbon oxide escaped from its secure geological storage. Comments to the proposed regulations suggested that this period was excessively long and would have a chilling effect on the willingness of investors to fund carbon capture projects.
In response to these comments, the recapture period for previously claimed credits was reduced from 5 years to 3 years. This is a welcome change that should be of particular importance to tax equity investors for whom the tax credits are of paramount importance.
The final regulations include a number of other changes and clarifications, including for:
- Contractual provisions in arrangements to ensure the capture, storage, or use in enhanced oil recovery (EOR) of carbon oxide;
- Procedures for electing to pass through the tax credit to the party securely storing the carbon oxide or using it in EOR;
- Requirements for a lifecycle analysis regarding utilization of carbon oxide;
- Allocating recaptured credits claimed by partnerships; and
- Consequences of failures to comply with required reporting provisions.