February 25, 2020 IRS clarifies two issues on claiming carbon capture credits, establishes safe harbors for compliance The IRS has released guidance on complying with the carbon capture credit under IRC Section 45Q as amended by the Bipartisan Budget Act of 2018 (BBA). In Notice 2020-12, released on February 19, 2020, the IRS addresses how to determine when construction has begun on a qualified facility or on carbon capture equipment that may be eligible for the IRC Section 45Q credit. In Revenue Procedure 2020-12, released the same day, the IRS establishes a safe harbor under which the IRS will treat partnerships as properly allocating the IRC Section 45Q credit. The IRS said it will not issue private letter rulings or determination letters on the issues in the guidance. Background IRC Section 45Q allows credits for qualified carbon oxide captured by taxpayers using carbon capture equipment at a qualified facility. A "qualified facility" is defined in IRC Section 45Q(d) as any industrial or direct air capture facility for which construction begins before January 1, 2024, and that captures certain amounts of qualified carbon oxide, depending on its size. Notice 2020-12: Determining when construction of a qualified facility has begun Effective for tax years beginning after December 31, 2017, construction of a qualified facility that includes carbon capture equipment must begin before January 1, 2024, to qualify for the IRC Section 45Q credit. Similar to prior Notices related to wind and solar, Notice 2020-12 establishes two methods under which taxpayers can establish when construction began; the physical work test and the 5% safe harbor. In addition, Notice 2020-12 explains the continuity requirement, under which a taxpayer must make continuous progress towards completion once construction has begun in order to qualify for the IRC Section 45Q credit. Notice 2020-12 provides a six-year safe harbor to satisfy the continuity requirement. Eligibility for the IRC Section 45Q credit for projects that take longer will be determined based on the relevant facts and circumstances. A taxpayer may satisfy one or both methods of establishing the beginning date of construction, but construction will be deemed to have begun, for purposes of the continuity requirement, on the date the taxpayer first satisfies one of the two methods. A qualified facility may be transferred without losing its qualification under the physical work test or the 5% safe harbor. There is an exception, however, for any work performed or amount paid for a transfer consisting solely of tangible personal property to an unrelated party. Methods for establishing beginning of construction Under the physical work test, construction of a qualified facility or carbon capture equipment begins at the start of physical work "of a significant nature," if the taxpayer maintains a continuous program of construction. Under Notice 2020-12, whether work is of a significant nature "focuses on the nature of the work performed, not the amount or the cost." Offsite work of a significant nature includes manufacturing components, such as those necessary for disposal of qualified carbon oxide in a secure geological storage. Onsite work that qualifies includes the installation of foundations, gathering lines and other equipment necessary for carbon capture processes. Preliminary work, however, such as securing financing, research, clearing a site, and preparing the site for building, is not considered physical work of a significant nature. Under the 5% safe harbor test, construction of a qualified facility or carbon capture equipment begins when a taxpayer (1) pays or incurs 5% or more of the total cost of the qualified facility or carbon capture equipment, and (2) makes continuous efforts to advance towards completion of the qualified facility or carbon capture equipment. The costs properly included in the depreciable basis of the qualified facility or carbon capture equipment are considered in making the calculation. Revenue Procedure 2020-12: Safe harbor for partnerships allocating carbon capture credits Revenue Procedure 2020-12 establishes a safe harbor under which partnerships will be treated as properly allocating, under IRC Section 704(b), the IRC Section 45Q credits. The IRS noted that compliance with the safe harbor does not necessarily mean that the partnership is otherwise entitled to validly claim the IRC Section 45Q credit. Under Revenue Procedure 2020-12, partnerships can include partners that are project developers and investors. To qualify for the safe harbor:
Implications The overall guidance on complying with the carbon capture credit under IRC Section 45Q takes an approach that will look familiar to taxpayers in the wind and solar industries. The guidance establishes the same fundamental rules for determining when a facility has begun construction, leveraging the requirement of physical work of a significant nature and providing for a 5% safe harbor. Notice 2020-12 also includes a continuity requirement (as in prior guidance) requiring taxpayers to maintain continuous construction (effort) to advance towards completion of the qualified facility or carbon capture equipment. The new six-year safe harbor for this continuity standard will significantly reduce the burden of demonstrating that there was continuity over the entire period from start of construction to project completion, reducing the risk that an otherwise qualified project will not qualify for the IRC Section 45Q credit. Additionally, the guidance provides more leniency in two particular areas compared to its renewable energy counterparts:
Overall, the guidance is a good start to support deployment of carbon capture technology because it presents viable paths for developing and financing carbon capture and storage projects. We are closely monitoring future guidance, particularly related to the following topics:
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