On July 1, 2021, the Internal Revenue Service published Revenue Ruling 2021-13, which provides guidance on three important issues related to the income tax credit for carbon oxide sequestration found in section 45Q of the Internal Revenue Code. Recall that section 45Q provides for a credit against a taxpayer’s income tax liability based on the amount of carbon oxide (a) captured using carbon capture equipment, (b) placed in service at a qualified facility and (c) disposed of, injected, or utilized in a specified manner. For more information on carbon capture and section 45Q tax credits, see here, here and here.
Revenue Ruling 2021-13 addresses the application of section 45Q to carbon dioxide captured with carbon capture equipment installed at a methanol plant that had existing carbon dioxide separation equipment. The plant produces methanol by first creating syngas from the natural gas input in an acid gas removal unit that removes carbon dioxide, and then converts the purified syngas gas into methanol. The acid gas removal unit was installed by the owner of the methanol plant and placed in service on January 1, 2017, from which time the separated carbon dioxide was released into the atmosphere. In 2021, an investor installed new carbon capture equipment at the plant to create a single process train for capturing, processing, and preparing to transport the carbon dioxide previously released into the atmosphere. The investor owned the new carbon capture equipment but did not acquire an ownership interest in either the acid gas removal unit or the methanol plant.
Revenue Ruling 2021-13 concludes that: (1) the acid gas removal unit is carbon capture equipment as that term is defined in section 1.45Q-2(c) of the Treasury regulations because one of its functions is to separate carbon dioxide from a natural gas stream; (2) the investor could claim the section 45Q tax credit even though it only owned the equipment it installed to capture the carbon dioxide and not any other equipment in the single process train; and (3) the relevant placed-in-service date for the carbon capture equipment for purposes of eligibility to claim the section 45Q credit was 2021, the date that the investor first placed the single process train in a condition of readiness for the specifically designed function of capturing, processing, and preparing carbon dioxide for transport for disposal, injection, or utilization, rather than relating back to 2017 when the acid gas removal unit had been placed in service. This third conclusion was important because the amount of the section 45Q tax credit was increased in 2018, meaning that the higher credit could be claimed by the investor and not the lower credit in place when the acid gas removal unit was placed in service.
It is the second conclusion above that provides new opportunities for owners of plant facilities to finance the investment in carbon capture equipment necessary to prevent emitting carbon dioxide produced at their facilities into the atmosphere. Instead of utilizing internal capital to finance the entire investment necessary for the plant facility and the carbon capture equipment, plant owners may turn to discrete investors for assistance in constructing, owning and operating the carbon capture equipment in a single process train, particularly those investors who can utilize the section 45Q tax credit to reduce their anticipated future income tax liabilities. Consider the case of a new plant facility being constructed by a project company the equity funding of which will be provided by a private equity firm whose investors are mostly tax-exempt institutions. Income tax credits like the section 45Q credit are of no value to those tax-exempt institutional investors and thus would not be considered in their determination of overall project rate of return. But if the ownership of the carbon capture equipment can be isolated in an investment vehicle separate from the project entity owning the plant facility, the investment vehicle owning the carbon capture equipment generating the section 45Q tax credit can target taxable investors who will place value on the section 45Q tax credits and consider those credits along with annual cash flow distributions in their determination of project rate of return. This, of course, is exactly what happens today in wind farm electricity generation projects in which taxable investors like certain financial institutions invest in “tax equity” to receive the benefit of the section 45 renewable energy tax credit. After this Revenue Ruling, project owners can target additional sources of equity capital in situations in which ownership of the main plant facility can be segregated from ownership of the carbon capture equipment creating the single process train.
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