IRS Releases Initial Guidance Regarding Section 45Q Carbon Sequestration Tax Credit
On February 20, 2020, the IRS issued its first round of guidance regarding the carbon sequestration tax credit found in Section 45Q (the “Section 45Q Credit”) of the Internal Revenue Code of 1986 (as amended, the “Code”) in the form of Notice 2020-12 (which may be found here) and Revenue Procedure 2020-12 (which may be found here). The Section 45Q Credit is allowed for carbon captured from “qualified facilities” and later used in commercial products, used in enhanced oil recovery or secured in a geological formation. In the case of industrial-source carbon dioxide that would have otherwise been released into the atmosphere, the amount of the credit is scheduled to rise gradually from $22.66 per metric ton in 2016 to $50 per metric ton in 2026 (and adjusted for inflation thereafter). For industrial-source carbon dioxide used as a tertiary injectant in a qualified enhanced oil or natural gas recovery project, the amount of the credit is scheduled to rise gradually from $12.83 per metric ton in 2016 to $35 per metric ton in 2026 (and adjusted for inflation thereafter).
The Section 45Q Credit may be claimed during the 12-year period beginning on the date the equipment is placed into service by the person who owns the carbon capture equipment and physically or contractually ensures the carbon capture. However, to be eligible for the Section 45Q Credit, construction of a qualified facility that includes carbon capture equipment must begin before January 1, 2024. In response to the IRS’ request for comments, many commenters requested guidance regarding the beginning of construction requirements under Section 45Q.
Notice 2020-12 provides guidance on the determination of when construction has begun on a qualified facility or on carbon capture equipment that may be eligible for the Section 45Q Credit. The Notice provides two familiar methods to establish beginning construction—by beginning physical work of a significant nature or by paying or incurring 5% or more of the total cost of the qualified facility or carbon capture equipment. Similar to wind and solar projects, Notice 2020-12 requires continuous progress towards completion once construction has begun. However, unlike the similar wind and solar guidance, where a project must be placed in service by end of the fourth year after beginning construction to qualify for the Continuity Safe Harbor, carbon sequestration projects may be placed in service up to the end of the sixth calendar year after beginning construction to qualify.
Additionally, the IRS released Rev. Proc. 2020-12, which establishes a safe harbor structure to ensure that the tax equity investor will be entitled to claim the Section 45Q Credit. The safe harbor guidelines are otherwise very similar to the existing PTC guidance found in Rev. Proc. 2007-65. Under Rev. Proc. 2020-12, carbon sequestration transactions are structured as partnership flip transactions. However, the new guidance applies a 50% contingent consideration requirement, rather than the 75% requirement found in Rev. Proc. 2007-65. This means at least 50% of the investor’s total capital contributions must be fixed and determinable obligations that are not contingent either in amount or in certainty of payment. Another distinction is that neither developers nor investors are permitted to have a call right. Put rights are available to investors as long as the price is not more than its fair market value determined at the time of exercise.
