ITC in Canada

July 1, 2023 / CES White Papers

By: Kasturi Pattalwar

Investment Tax Credits and Canada Energy Market

Canada has been one of the leading countries to promote clean energy. Existing grid of Canada consists of approximately 83% of cleaner resources. Most of the Canada’s electricity comes from hydro resources. Some parts contain nuclear, solar and wind too. To continue Canada’s commitment towards net zero emissions and thus cleaner grid, various government agencies have been supporting renewable energy (RE) projects in the form of dedicated procurements and various schemes are launched. This article discusses one such important policy structure called Investment Tax Credits (ITC) from a Canadian project point of view.

What is a Tax Credit: Tax credits are incentives provided for investing in clean energy projects that directly reduce the amount of tax liability. It is a dollar-for-dollar reduction in the eligible tax amount, meaning that each tax credit dollar claimed reduces the actual tax owed by one dollar. Generally, these credits can be claimed for initial few years for a project and do not go over the lifetime. In the Investment Tax Credit mechanism, investments made for some specific costs such as procurement of clean energy equipment and labor cost for its installation are included for the redemption and all costs are not included.

Encouragement to capital investments in Renewables: For encouraging growth of Renewable Energy sector, it is very important create healthy business environment for such projects which in turn supports the rounded growth of various stakeholders in the sector. Most of the RE projects are considered “risk prone” and thus are equity backed. Although there has been some confidence shown by a few debt investors, there are very limited examples of such. To support the growth of this sector and encourage investors, programs like tax incentives are popular in some countries including the USA. By reducing the cost of investment, ITCs encourage businesses to expand their operations, modernize their infrastructure, and adopt innovative technologies. This, in turn, stimulates economic activity and job creation.

Promoting technological development: When ITC was first introduced in the US in 2006 for a limited period, upon receiving tremendous response, it has been continued since. Initially, the cost of renewable energy technology and its installation was high due to its early nature. Post ITCs, there has been visible investment in the research and development of the technology making it accessible at ease. As per Solar Energy Industry Association’s report there was 24% rise in the solar installations in the US since 2006 and reduction of solar system prices by more than 50% from year 2010 to year 2022. Among many others, one major cause of this growth is ITC. This has hugely helped Canadian renewable energy market also. Reducing costs of renewable technology has cause increase in large scale installations in Canada. Market of Hydrogen as a clean source of energy is increasing in Canada and thus needs a boost from government. Hence, declaration of Hydrogen ITC will support the growth of this technology and its implementation from an industrial point of view.

Fostering industry growth: After reaching certain maturity in technological development, it becomes important to keep up the pace and foster growth. In 2022, with the announcement of Inflation Reduction Act (IRA), US government has restructured ITC along with inclusion of few newer technologies supporting clean electricity generation. To establish this sectoral growth, Canada government has also announced ITC in 2023 budget. It is structured in a manner to incentivize the development in this sector.

Encouraging Foreign Direct Investment (FDI): Canada and US always had a symbiotic relationship with respect to doing business. US business policies have impacted Canada’s growth policies in a positive way. After Biden Administration’s IRA announcement, Canada needed to extend their support to the growth of Renewable Energy sector to maintain their investor’s interest. To establish a competitive tax environment, making it more attractive for businesses to invest in Canada, this ITC regime is launched.

Canadian Budget 2023: There are different tax credits mentioned in the budget 2023:

  1. Clean Electricity Investment Tax Credit – 15% refundable credit provided for investments in generation and transmission of clean electricity such as Renewables, stationary storage, low carbon heat and electricity equipment, zero emission vehicles
  2. Clean Technology Manufacturing Tax Credit – up to 30% refundable credit given to procure machinery and equipment used for manufacturing or processing clean energy technologies.
  3. Clean Hydrogen Investment Tax Credit – a support extended between 15% to 40% of costs of producing low carbon intense hydrogen
  4. CCUS Investment tax credit – this is an expansion of carbon capture, utilization and storage investment tax credit for additional types of equipment used to capture carbon dioxide emissions
  5. Clean technology Investment tax credit – special inclusion of geothermal energy systems to develop this sector

Impact of ITC from project point of view: There are two types of tax credits which can support a project. When a refundable tax credit is received by a project, it can directly add monetary benefits to the project. They can potentially result in a net positive cash flow for the project improving economics of the project. On the other hand, in a non-refundable tax credit system, if tax liability of the project is lesser than applicable credits, the credit is wasted.  For example, a project has a liability of $100 and has credits worth $150. In a refundable regime, tax liability of that project becomes zero and excess of $50 credit can be refunded as cash balance. Whereas in a non-refundable regime tax liability becomes zero but there is loss of excess credits worth $50. In such a regime, if credits are regarded transferable under the tax rule, there is a possibility of transfer of these excess credits to gain cash benefits by virtue of sale. In most cases when tax liability of the project is lower in initial years of the project due to lower returns, there is loss of unutilized portion of the tax credit. If these unutilized credits can be transferred to another investor for their corporate taxation purpose, there can be monetary gain for the project as well and tax reduction for the investor. A win-win! ITCs in Canada are refundable whereas the recent amendment if ITCs in the US allows transfer of ITCs.

Opportunities to improve: Although there are few details to be further investigated and released by the government, there are few preliminary developments possible in the ITC structures in Canada.

  1. Design and Implementation: Even though this ITC announcement is a welcome move, nuances from the implementation point of view are not considered in the budget. For example, project specific relevance of combinations of credits and government’s other applicable incentives, implementation to under development projects is yet to be investigated and confirmed.
  2. Unclear provisions: There are still debates over structural details like inclusions of various material and soft costs, credit calculations for projects consisting of multiple energy sources. Clear guidelines will help to structure the project in a better manner.
  3. Need of flexibility: Considering maturity of the Renewable Energy sector in Canada, there is room for creating newer structures of financing and this increasing business activity. Parameters like partnership laws and Tax Equity investment need to be explored. There is a need to increase flexibility of the ITC structure to incorporate such parameters in a clean energy project.
  4. Vague hydrogen ITC: Hydrogen ITC is a hasty declaration and needs a lot more depth from the industry implementation point of view. Parameters like definition of clean hydrogen, intensity of carbon in the production, level of support needed for various modes of hydrogen production need to be further studied.
  5. Pressure on government: Since the ITCs are refundable in this regime, government needs to bear the cost of tax benefits being credited to the clean energy projects. By implication, it creates pressure on the taxpayer. If the ITC are non-refundable and transferable, it supports business activity in the sector.