Clean and renewable energy initiatives are at the forefront of global action and government policy as efforts are made to adapt to climate change and meet commitments to reduce greenhouse gas emissions. Consistent with this, the Government of Canada (the “Government”) has strengthened its commitment to the foregoing through its recently announced Budget 2023. Principally, the Government has made advancements in establishing Canada as a “safe, smart, and competitive place to do business”; seeking to attract clean and renewable investments in the Canadian energy industry, in the face of severe competition from the U.S. in light of the American Inflation Reduction Act of 2022.

Canada’s renewed commitment is structured to offer investment certainty through a number of initiatives, including Carbon Contracts for Difference, and a multitude of Investment Tax Credits for clean electricity projects, clean technology acquisition, clean technology manufacturing, critical mineral extraction and processing, and projects for carbon capture, utilization and storage.

Together, CCfDs and the various ITCs are intended to foster a new national program aimed at securing investment in carbon reduction projects and growing an enhanced economy based in the cleantech and clean energy sectors.

A) CARBON CONTRACTS FOR DIFFERENCE (“CCFD”)

According to Budget 2023, CCfD will provide a new investment tool with which the $15B Canada Growth Fund can support clean growth projects. Canadian businesses considering decarbonisation projects and technological innovation are hesitant to make the needed investments because of the uncertainty associated with revenues from selling carbon reductions or excess allowances, since future carbon prices are difficult to predict. This is particularly true because the technological advancements are occurring in parallel and carbon markets remain at an early stage of development.

CCfD are intended to address this uncertainty by bridging financial and regulatory gaps to encourage low carbon technologies and renewable energy projects. CCfD are contracts by which a government agrees with the counterparty on a fixed carbon price over a fixed period of time. During this period, the counterparty is guaranteed the contracted price for any sales of carbon emission reductions or excess allowances generated by the project. If the carbon market price at which the credit is sold is higher that the contracted strike price, the counterparty returns the additional revenue to the government. If the carbon market price is lower than the strike price, the counterparty receives the difference.

Although new to Canadian markets, CCfD are commonly used in Europe. In Canada, CCfD offer opportunities in the renewable energy industry, such as for hydrogen, wind and solar energy projects. The CCfD is favourable for generators and other interested parties because it guarantees a set revenue for the carbon credits (whether carbon emission reductions or excess allowances) that are generated by the project.

In addition to acting as a hedging tool for future carbon prices and to stabilize revenues for renewable energy projects, they also provide regulatory credibility to fledgling industries. This is because governments are incentivized to help keep carbon market prices high so that the financial cost of the underlying CCfD will be lower. This then provides assurances to those developing and utilizing new innovations — both in terms of government support but also that markets will exist for their energy, products and technology.

CCfD do have their limitations, however:

B) INVESTMENT TAX CREDITS

 i. Clean Electricity Investment Tax Credit

As Canada has structured a significant portion of Budget 2023 around investment in clean and renewable energy, an increased reliance on a clean electric grid is paramount. With the nation’s electricity demand expected to double by 2050, Canada’s electric grid and capacity must increase by 2.2 to 3.4 times its current state. The Government posits investment tax credits as the anchor in which significant investments in the clean energy evolution will occur. An investment tax credit for clean electricity will function as the vehicle for such targets.

The clean electricity investment tax credit (the “CE Credit”) introduces a 15 per cent refundable tax credit for eligible investments in:

The CE Credit is proposed to become available on Budget Day 2024 for projects that did not begin construction prior to March 28, 2023. The CE Credit is scheduled to remain in effect through 2034, and no phase-out period was referenced in the budget materials.

Eligibility for the full CE Credit rate will be dependent on adherence to certain labour requirements, as described below. Failure to adhere to the prescribed labour requirements would see the applicable CE Credit rate reduced to 5 per cent.

Access to the credit will also require a commitment by a competent authority that the federal funding will be used to lower electricity bills, and a commitment to achieve a net-zero electricity sector by 2035. Additional details regarding these commitments and any other requirements can be expected to emerge following consultations between the federal government and its provincial and territorial counterparts.

ii. Clean Hydrogen Investment Tax Credit

Canada has made significant strides in diversifying its energy production. As noted above, clean electricity is a cornerstone in the country’s energy evolution. Attached to these developments is the utility of clean hydrogen as a fuel source for trucking, marine, and aviation transport. As with the development of clean technology, hydrogen’s practicality hinges on increased investment.

To spur such growth, Budget 2023 implemented the clean hydrogen investment tax credit (the “CH Credit”), a refundable tax credit on the cost of purchasing and installing “eligible equipment” for projects that produce hydrogen from (i) electrolysis, or (ii) natural gas, so long as emissions are abated using carbon capture, utilization and storage (CCUS).

The CH Credit ranges from 15 to 40 per cent of project costs, depending on the carbon intensity of the hydrogen produced, as assessed pursuant to the Fuel Life Cycle Assessment Model maintained by Environment and Climate Change Canada, and submitted to the government for verification:

The CH Credit is available in respect of eligible equipment that is acquired, and becomes available for use in Canada, on or after March 28, 2023, but is reduced by half for property acquired and available for use in 2034, and eliminated after 2034. In order for equipment to be eligible, all or substantially all of its use must be to produce hydrogen through either electrolysis or from natural gas. Equipment used to produce hydrogen from natural gas would only qualify if it does not otherwise qualify for the CCUS Credit (discussed further below).

For projects that rely on ammonia production, the CH Credit permits a 15 per cent tax credit toward equipment used to convert hydrogen into ammonia for transportation purposes.

Paired with the credit are the prescribed labour requirements, which if not met, will reduce the credit rate by 10 percentage points.

iii. Clean Technology Investment Tax Credit

The Clean Technology Investment Tax Credit (the “CT Credit”), originally announced in the Government’s 2022 Fall Economic Statement (FES 2022), has been expanded. The CT Credit is a refundable tax credit equal to 30 per cent of the cost of eligible property that is acquired, and becomes available for use, on or after March 18, 2023 and before 2035. The CT Credit rate is reduced to 15 per cent in 2034 and will be eliminated in 2035.

FES 2022 provided the following list of eligible property for the CT Credit:

Budget 2023 expands the initially proposed list to include equipment described in subparagraph (d)(vii) of Class 43.1 and used primarily for the purpose of generating electrical energy, heat energy, or both, solely from geothermal energy. Examples of such equipment would include piping, pumps, heat exchangers, steam separators, and electrical generating equipment. It is important to note that equipment used for geothermal energy projects that co-produce fossil fuels are not eligible for the CT Credit.

As is the case for the CH Credit, eligibility for the full CT Credit rate is dependent on adherence to certain prescribed labour requirements. The CT Credit rate is reduced to 20 per cent (or 10 per cent in 2034) for businesses that fail to meet the prescribed requirements, which are discussed in more detail below.

iv. Clean Technology Manufacturing Investment Tax Credit

Critical minerals are the contemporary focus of the Canadian energy sector, with The Canadian Critical Minerals Strategy (the “Strategy”) released in December 2022. The Strategy emphasizes the intersection of critical minerals and modern technology — this sentiment having been reproduced in Budget 2023 in the form of an investment tax credit for clean technology manufacturing (the “CTM Credit”).

While the CT Credit is designed to encourage the adoption of clean technologies, the CTM Credit is targeted to those that are manufacturing or processing clean technologies and their precursors.

The CTM Credit is a 30 per cent refundable investment tax credit for investments in new machinery and equipment used to manufacture or process key clean technologies, or to extract, process, or recycle key critical minerals, as well as related control systems.

The CRM Credit is available in respect of the capital cost of certain eligible depreciable property all or substantially all of the use of which is for any of the following eligible activities:

v. Carbon Capture, Utilization, and Storage Tax Credit

Carbon Capture, Utilization, and Storage (“CCUS”) technology centres on capturing carbon dioxide emissions from the atmosphere to either relocate in storage or use in other manufacturing processes. First featured in Budget 2022, the Carbon Capture, Utilization, and Storage Investment Tax Credit (the “CCUS Credit”) will now include dual-use equipment that produces heat and/or power, or uses water, and is used for both CCUS as well as another process (provided that such equipment satisfies all other conditions of the CCUS Credit). In order for dual-use power and/or heat production equipment to be eligible, CO₂ emissions would need to be captured, stored or used, and such equipment would need to be primarily used to support either the CCUS process or hydrogen production that is eligible for the CH Credit.

In addition, other updates to the CCUS Credit include:

vi. Labour Requirements for CE, CH and CT Credits

Eligibility for the full benefit of each of the CE Credit, CH Credit, and CT Credit is dependent on the recipient’s adherence, beginning on October 1, 2023, to certain labour requirements relating to wage and apprenticeship targets in respect of the project benefiting from the applicable credit. The labour requirements apply to workers (whether employees or contractors) primarily engaged in manual or physical labour, and do not apply to those in administrative, clerical, supervisory, or executive roles.

The wage requirement generally requires that workers involved in the project be paid at or above a “relevant wage” (taking into account the monetary value of standard benefits and pension contributions) as specified in an “eligible collective agreement”. In Québec, such an agreement would be one negotiated in accordance with provincial law. For territories and provinces other than Québec, an “eligible collective agreement” would be the most recent multi-employer collective bargaining agreement between a trade union and a group of employers that may reasonably be considered the industry standard for the given trade in the particular region, province or territory.

The apprenticeship requirement generally requires that, subject to applicable labour laws and collective agreements, not less than 10 per cent of the total labour hours of covered workers on a particular project be performed by registered apprentices. “Covered workers” in this context refers to workers whose duties correspond to those performed by a journeyperson in a Red Seal trade.

vii. Situations Involving Multiple Tax Credits

Given the nature of the eligibility criteria underlying each credit regime, it is certainly possible for a single piece of equipment or property to meet the criteria for multiple credits. Budget 2023 provides that, in such cases, only one credit may be claimed in respect of the relevant piece of property or equipment. Accordingly, taxpayers should carefully analyze which credit offers the greatest benefit in their circumstances having regard to the eligibility requirements. The highest credit rate available is under the CH Credit regime, which provides a 40 per cent credit for eligible costs where the project achieves the lowest carbon intensity threshold and fully complies with the prescribed labour conditions.

C) OTHER TAX INCENTIVES

i. Continued Reduced Tax Rates for Zero-Emission Technology Manufacturers

Budget 2021 introduced reduced tax rates on eligible zero-emission technology manufacturing and processing income for qualifying manufacturers. Budget 2023 provides that, for years beginning after 2023, eligible income would include income from the manufacturing of nuclear energy equipment, processing or recycling of nuclear fuels and heavy water, and manufacturing of fuel rods.

Budget 2023 also extends the availability of the reduced rates by an extra three years. The rates will now be subject to a phase-out beginning in 2032, with elimination scheduled for 2034.

ii. Inclusion of Lithium from Brines as a Critical Mineral

Budget 2023 proposes to include lithium from brines as a mineral resource and a critical mineral for purposes of the Tax Act. Beginning March 18, 2023, expenses related to lithium from brines will be eligible for qualification as Canadian exploration expense or Canadian development expense, and be eligible for the Canadian mineral exploration tax credit that was introduced in Budget 2022.

D) PIECING THE NARRATIVE TOGETHER

CCfDs coupled with the tax incentives signify that the Canadian energy industry is playing a central role in the Government’s plans for economic growth. At the same time, it is important to be mindful of potential risks and the keys to successful implementation.

Beginning with CCfDs, their practicality and effectiveness in Canada is limited, although their widespread use and acceptance in Europe is promising. Further, the administrative complexity and potential restrictions of a CCfD and a regulatory system that must adapt to these changes could be significant hurdles. Further, their effectiveness may be limited depending on how they are awarded, and given that they only provide price certainty for one element of the financial model.

Complications with respect to the tax incentives are less apparent at this point, though it will be necessary for project managers and investors to become familiar with the eligibility requirements which will determine whether the tax credits can be maximized.

Budget 2023 equips Canada with the foundational tools and a strategic plan to increase investment in clean and renewable energy projects and technology. If such continued efforts have the anticipated impact of supporting the burgeoning clean energy sector, there may be lasting effects on the march towards a dynamic green and clean economy.

1. This article is a revised and combined version of (i) Ted Thiessen, “Budget 2023: Clean Energy Incentives and Resource Sector Measures” (23 March 2023), online: McMillan LLP <mcmillan.ca/insights/budget-2023-clean-energy-incentives-and-resource-sector-measures>; and (ii) Julia Loney & Mike Richmond, “Canada’s Budget 2023: Compromise and Competition – Climate, Carbon and CCfDs”, online: McMillan LLP <mcmillan.ca/insights/canadas-budget-2023-compromise-and-competition-climate-carbon-and-ccfds>.

* Mike Richmond, Ted Thiessen and Julia Loney are partners at McMillan LLP.

Ryan Johnson is an articling student with the firm.