2022 Canadian Federal Budget: Business Tax

Consistent with recent federal budgets, Budget 2022 included a number of tax measures intended to support Canada's climate objectives by incentivizing investment in and development of clean technology, while seeking to limit or remove certain tax incentives previously afforded to carbon-based industries, specifically oil, gas and coal.

Investment tax credit for carbon capture, utilization and storage

Budget 2022 proposed a specific investment tax credit (CCUS ITC) for carbon capture, utilization, and storage (CCUS) with a stated expectation of having a positive environmental impact by encouraging investment in technologies that would reduce emissions of greenhouse gases. The CCUS ITC would apply for eligible expenditures incurred starting on January 1, 2022, and importantly for taxpayers is proposed to be refundable. 

While significant details regarding the CCUS ITC, the process for qualifying for the CCUS ITC, and certain detailed “knowledge sharing” and “climate risk disclosure” requirements will be provided later, Budget 2022 provided the framework and certain basic details about the contemplated eligible expenses, credit rates and project requirements. Given the measures are proposed effective January 1, 2022, the timing of the release of specific legislation and government process for approving and administering the CCUS ITC will be key to allowing taxpayers to utilize the program in 2022.

Eligible Projects

As a starting point, applicable expenses must be part of a new project that captures CO2, prepares the captured CO2 for compression, compresses and transports the captured CO2, and stores or uses the captured CO2. While storage can potentially be outside Canada, the project must capture CO2 in Canada that would otherwise be released into the atmosphere or capture CO2 from the ambient air. Certain projects where emissions reductions are necessary as part of coal- and gas-fired electricity generation regulations are not eligible projects. 

While the process is yet to be determined, Budget 2022 provided that projects with expenses over $100 million must, and other projects may, undergo an initial project tax assessment to identify expenses eligible for the CCUS ITC and the tax credit rate that is expected to apply. In addition to the initial project assessment, expenses need to be verified by Natural Resources Canada after the year end and before filing tax returns in order for the CCUS ITC to be refunded upon filing. 

Although not described in Budget 2022, the process for the initial review could be designed similar to the existing review process for Canadian Renewable and Conservation Expenses and qualification of expenses for capital cost allowance under Class 43.1 and Class 43.2 with Natural Resources Canada and the Canada Revenue Agency. Given the significant capital involved and that the CCUS ITC is refundable, one would expect that the validation process will be highly technical, require taxpayers to answer follow-up questions and require verification. Further, once projects begin capturing CO2 they will be assessed every five years to determine if the CCUS ITC should be recovered. 

In addition to the initial project assessment, to be eligible for the CCUS ITC there are two further unique documentation requirements. First, projects with expenses over $250 million would be required to contribute to public knowledge sharing in Canada to be eligible for the CCUS ITC. Second, taxpayers would be required to produce a climate-related financial disclosure report highlighting their contribution to achieving Canada’s commitments under the Paris Agreement and goal of net zero by 2050.

The project must have an “eligible use” of the CO2 being captured and initially includes dedicated geological storage and storage in concrete. Enhanced oil recovery is specifically not eligible. Geological storage is currently only permitted in Alberta and Saskatchewan, as such provinces have the sufficient regulations required to ensure that CO2 is permanently stored as determined by Environment and Climate Change Canada. Storage in concrete must be approved by Environment and Climate Change Canada and demonstrate that at least 60% of the CO2 that is injected into the concrete is mineralized and locked into the concrete produced. 

Technical Scheme

The technical scheme of the measure is the creation of two new capital cost allowance (CCA) classes and the CCUS ITC. Amounts eligible for the CCUS ITC would not be included in the new capital cost allowance classes. Equipment included in the CCA classes would include equipment that will be used solely to capture, transport, store, or use CO2 as part of an eligible CCUS project. The CCUS ITC rates outlined in Budget 2022 range from 18.75% to 60%. The highest rate is for direct air capture projects and otherwise vary based on the nature of the expenses and when the expenses are incurred.

The first CCA class for CCUS equipment will provide for an 8% capital cost allowance rate on a declining-balance basis and include equipment that solely captures CO2, and transportation and storage equipment. The second CCA class for CCUS equipment will provide for a 20% capital cost allowance rate on a declining-balance basis and include equipment required for using CO2 in the eligible use.

Certain expenses are specifically excluded such as equipment required for hydrogen production, natural gas processing, acid gas injection or that does not support CCUS, feasibility studies, front-end engineering design studies and operating expenses. Exploration and development expenses associated with storing CO2 would also not be eligible for the CCUS ITC but will be added to two other new CCA classes (with deduction rates of 100% and 30%) for intangible exploration expenses and development expenses associated with storing CO2.

Critical Mineral Exploration Tax Credit

Budget 2022 announced the federal government's intention to implement a "Critical Minerals Strategy" to "secure Canada's place" in global supply chains of critical minerals, being those minerals that are used in clean technology, health care, aerospace and computing. Examples of critical minerals include lithium, cobalt, rare earth elements, and nickel, among others. 

In addition to a number of direct investments aimed at supporting the development of critical minerals supply chains in Canada, Budget 2022 announced the creation of a new "Critical Mineral Exploration Tax Credit" (the CMETC). The CMETC is proposed to be a 30% tax credit made available to certain investors who subscribe for flow-through shares in mining companies that undertake exploration for critical minerals in Canada. 

The CMETC is proposed to function similarly to the existing "Mineral Exploration Tax Credit" (the METC). First introduced in 2000, the METC allows individuals who have subscribed for flow-through shares of a mining company to claim a tax credit equal to 15% of flow-through renunciations they receive in connection with specified mineral exploration expenses incurred by the company. The METC enhances the tax benefits otherwise associated with flow-through shares, and often allows a mining company to realize greater capital investment to fund exploration work. The CMETC will effectively double the METC where exploration expenses are incurred and renounced to individual flow-through subscribers in connection with designated critical minerals. 

The designated critical minerals for which the CMETC will be available are copper, nickel, lithium, cobalt, graphite, rare earth elements, scandium, titanium, gallium, vanadium, tellurium, magnesium, zinc, platinum group metals and uranium. 

For renunciations of expenses to qualify for the CMETC, Budget 2022 indicates that a qualified engineer or geoscientist who is a "qualified person" for purposes of National Instrument 43-101 will be required to certify that the expenses to be renounced will be incurred in connection with exploration that targets the designated critical minerals. It is unclear from Budget 2022 as to what form this certification will be required to take.

The CMETC is available for eligible exploration expenses that are renounced under flow-through share agreements entered into after budget day and on or before March 31, 2027. 

Clean technology incentives – air-source heat pumps

Expansion of Classes 43.1 and 43.2 

Budget 2022 announced the continued expansion of CCA Classes 43.1 and 43.2 to include additional clean technology equipment. Specifically, Budget 2022 announced the intention to expand Classes 43.1 and 43.2 to include equipment used in air-source heat pump systems, which are described in Budget 2022 as an energy efficient and zero-emission alternative to traditional heating. To be included, the equipment must be used in an air-source heat pump system that primarily heats spaces (i.e., buildings) or water, and must be acquired and available for use on or after budget day. 

Property included in Class 43.1 or 43.2 is generally eligible for depreciation at rates of 30% and 50% respectively, though pursuant to rules announced in 2018, any such property that becomes available for use prior to 2024 is eligible for an accelerated 100% rate of depreciation, with a gradual phase out of the accelerated rate for property that becomes available for use after 2023 and prior to 2028.

Rate reduction for manufacturers of air-pump heat systems

In addition to enhanced depreciation of equipment used in air-source heat pump systems, Budget 2022 announced that manufacturers of air-source heat pump systems would be eligible for the reduced tax rates applicable to eligible zero-emission technology manufacturing and processing income that were announced in Budget 2021. The reduced rates of 7.5% on income otherwise taxed at the ordinary corporate rate, and 4.5% on income that would otherwise benefit from the small business tax rate, are applicable for taxation years beginning after 2021, subject to a gradual phase out of the reduced rates from 2029 to 2031. 

Elimination of flow-through shares for oil, gas and coal activities

Budget 2022 announced the intention to eliminate the flow-through share regime for expenses incurred in connection with oil, gas and coal exploration and development.

As proposed, companies will not be able to renounce expenditures incurred in connection with oil, gas or coal exploration and development activities under flow-through share agreements made after March 31, 2023.  Notably, Budget 2022 does not suggest any changes to or limitations on the ability of companies to incur and renounce such expenditures under flow-through agreements made on or before March 31, 2023.

Other clean technology credits

In addition to the proposals outlined above, Budget 2022 also announced the intention to establish a new investment tax credit of up to 30% that will be focused on "net-zero technologies, battery storage solutions, and clean hydrogen." Details of the new tax credit will be made available in the 2022 Fall Economic and Fiscal Update. 

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