Firm Notes Ambiguity in Carbon Oxide Sequestration Credit Provisions

June 8, 2023

Internal Revenue Service
CC:PA:LPD:PR (Notice 2022-57)
Room 5203
P.O. Box 7604
Ben Franklin Station
Washington, D.C. 20044

The Honorable Lily L. Batchelder
Assistant Secretary for Tax Policy
United States Department of the Treasury
1500 Pennsylvania Ave., N.W.
Washington, D.C. 20220

Mr. William M. Paul
Principal Deputy Chief Counsel and Deputy Chief Counsel (Technical)
Internal Revenue Service
1111 Constitution Ave., N.W.
Washington, D.C. 20224

Re: Comments Pursuant to Notice 2022-57 Regarding the Exception to Prevailing Wage Requirements in I.R.C. Section 45Q(h)

Dear Madam and Sir:

Baker Botts L.L.P. respectfully submits these comments pursuant to Notice 2022-57, 2022-47 I.R.B. 482, which requests comments on questions arising from amendments made by the Inflation Reduction Act of 2022 (the “IRA”) to section 45Q of the Internal Revenue Code of 1986, as amended (the “Code”).¹

As a result of conferring with a number of our clients who are actively engaged in the carbon capture industry, it has come to our attention that there is confusion regarding the application of the prevailing wage and apprenticeship (“PWA”) requirements under section 45Q(h) and the exceptions thereto. As explained further below, depending upon the interpretation of  section 45Q(h), the requirements could potentially work to prevent a taxpayer from receiving the full credit amount (the 5x multiplier) if it does not satisfy the PWA requirements when constructing the emitting facility even though the taxpayer had no plans for carbon capture and sequestration at the time of such construction.

Such an interpretation would mean that a taxpayer who installs carbon capture equipment at an industrial facility, the original planning for which did not contemplate carbon capture and therefore the construction of which did not comply with the PWA requirements, would be precluded from obtaining the full section 45Q credit amount despite satisfying the PWA requirements with respect to the eventual construction and installation of a completed carbon capture process train. Without guidance that clarifies and corrects such an interpretation of section 45Q(h), we foresee a chilling effect on installing carbon capture equipment at industrial facilities, thereby frustrating the clear legislative intent of the IRA to incentivize carbon capture and promote industrial decarbonization in the United States.

We describe in detail below the interpretive issues raised by the provisions of section 45Q(h). We also make suggestions for the manner in which guidance could address these issues.

Procedural Matters

These comments are responsive to section 3.06 of Notice 2022-57, which provides: “Please provide comments on any other topics related to section 45Q that may require guidance.” These comments are also responsive to sections 3.01 and 3.02 of Notice 2022-51, 2022-43 I.R.B. 331, requesting comments on any other topics relating to the PWA requirements.

Although the original deadline for comments in response to Notice 2022-57 (that is, December 3, 2022) has passed, since the Notice states that consideration will be given to any comments submitted after the deadline if such consideration will not delay the issuance of guidance, we are submitting these comments at this time. We do not believe consideration of these comments will delay the issuance of guidance.

Section 45Q(h) — Prevailing Wage and Apprenticeship Requirements

The IRA amended section 45Q(h) to allow for an enhanced section 45Q credit amount if the carbon capture equipment, and the qualified facility into which the carbon capture equipment is installed, satisfy or are excepted from the PWA requirements. In particular, section 45Q(h)(1) provides that in the case of any qualified facility or any carbon capture equipment which satisfy the requirements of section 45Q(h)(2), the amount of the credit shall be multiplied by 5. Section 45Q(h)(2) provides:

(2) Requirements.

The requirements described in this paragraph are that —

(A) with respect to any qualified facility the construction of which begins on or after [January 29, 2023],² as well as any carbon capture equipment placed in service at such facility (i) . . . the taxpayer satisfies the [prevailing wage requirements] with respect to such facility and equipment, and (ii) the taxpayer satisfies the [apprenticeship requirements] with respect to the construction of such facility and equipment,

(B) with respect to any carbon capture equipment the construction of which begins on or after [January 29, 2023], and which is installed at a qualified facility the construction of which began prior to such date (i) . . . the taxpayer satisfies the [prevailing wage requirements] with respect to such equipment, and (ii) the taxpayer satisfies the [apprenticeship requirements] with respect to the construction of such equipment, or

(C) the construction of carbon capture equipment begins prior to [January 29, 2023], and such equipment is installed at a qualified facility the construction of which begins prior to such date.

The specific issue of concern is presented by section 45Q(h)(2)(A), which requires, among other things, satisfaction of the PWA requirements with respect to not solely the carbon capture equipment but both the carbon capture equipment and the qualified facility if the qualified facility begins construction on or after January 29, 2023. If this requirement is interpreted to mean that the PWA requirements must be satisfied with respect to the construction of the industrial facility, before it is known or even expected to be within the definition of a “qualified facility,” then taxpayers constructing industrial facilities — even those who have no plans of later installing carbon capture equipment at such facilities — would need to satisfy the PWA requirements just to preserve eligibility for claiming the full section 45Q credit amount. Such an interpretation would have a particularly negative impact on those facilities that eventually implement new and emerging technologies for carbon capture but that are not envisioned at the time of construction of the facility.³

In evaluating this issue, it is useful to note the definition of “qualified facility.” Section 45Q(d) defines a “qualified facility” as “any industrial facility⁴ or direct air capture facility (1) the construction of which begins before January 1, 2033, and either construction of carbon capture equipment begins before such date, or the original planning and design for such facility includes installation of carbon capture equipment, and (2) which [meets certain minimum capture thresholds].” Therefore, under this definition, an industrial facility that has no plans for carbon capture and no components of carbon capture equipment when it is constructed only becomes a “qualified facility” at a later time, if and when carbon capture equipment (that also begins construction before January 1, 2033) is installed at the industrial facility and such facility meets certain minimum capture thresholds as a result. Thus, if an industrial facility is not, and has no plans to become, a “qualified facility” at the time of its construction, the PWA requirements should not be interpreted as applying to the construction of such industrial facility.

We present two examples below to illustrate the concern. Example B is based on the facts of Rev. Rul. 2021-13, 2021-30 I.R.B. 152.

Example A

Facts: Taxpayer begins construction of a chemical facility⁵ on or after January 29, 2023. The operations of the chemical facility will emit a stream of carbon dioxide into the atmosphere, but Taxpayer does not have technology that will permit it to isolate and capture the carbon dioxide. No components of carbon capture equipment are included in the chemical facility. Having no plans for carbon capture or to claim the section 45Q tax credit, Taxpayer does not comply with the PWA requirements in the construction of the chemical facility. Some years thereafter (but before January 1, 2033), Taxpayer develops a technology that will allow it to isolate and capture the carbon dioxide. Taxpayer then constructs and installs a completed carbon capture process train at the chemical facility. The carbon capture process train meets the minimum carbon capture thresholds. Taxpayer satisfies the PWA requirements with respect to such later construction of the completed carbon capture process train.

Analysis: Under section 45Q(d), the chemical facility is a “qualified facility” because it is an industrial facility that began construction before January 1, 2033, the carbon capture equipment installed at such facility (that is, the completed carbon capture process train) began construction before January 1, 2033, and the chemical facility meets the minimum capture thresholds. Thus, although the chemical facility as originally planned and designed was not a “qualified facility,” it became a qualified facility upon the installation of the completed carbon capture process train. If Section 45Q(h)(2)(A) is applied to mean that Taxpayer must have complied with the PWA requirements as to the construction of the chemical facility, even though the chemical facility had no plans for carbon capture and included no carbon capture equipment at the time of its construction, then Taxpayer would not have met the requirements necessary for it to obtain the credit multiplier.

Example B

Facts: Taxpayer begins construction of a syngas facility on or after January 29,2023. The facility includes an acid gas removal (AGR) unit that removes from the syngas a carbon dioxide stream which is then vented into the atmosphere. Taxpayer has no plans for carbon capture; construction of the facility does not include plans for a complete carbon capture process train or other equipment used for the capture, processing and preparation of carbon dioxide for transport for disposal, injection, or utilization. Having no plans for carbon capture or to claim the section 45Q tax credit, Taxpayer does not satisfy the PWA requirements in its construction of the facility. Some years thereafter (but before January 1, 2033), Taxpayer decides to construct and install a completed carbon capture process train in the facility, which would capture the carbon dioxide in amounts meeting the minimum capture thresholds under section 45Q(d)(2). Taxpayer satisfies the PWA requirements with respect to such later construction of the completed carbon capture process train.

Analysis: As determined in Rev. Rul. 2021-13, the AGR unit is considered a component of carbon capture equipment because one of its functions is to separate carbon dioxide from the syngas. Under section 45Q(d), the syngas facility is seemingly a “qualified facility” at the time of construction because it is an industrial facility that began construction before January 1,2033, the construction of carbon capture equipment (that is, the AGR unit) began before January 1, 2033, and the amount of carbon dioxide separated by the AGR unit meets the minimum capture thresholds. However, if section 45Q(h)(2)(A) is applied to mean that Taxpayer must have complied with the PWA requirements as to the construction of the syngas facility, even though the syngas facility had no plans for carbon capture and had only a single component of carbon capture equipment at the time of construction, then Taxpayer would not have met the requirements necessary for it to obtain the credit multiplier.

As illustrated by the examples above, applying the PWA requirements to the construction of a qualified facility before it has a completed carbon capture process train or indeed any components of carbon capture equipment whatsoever results in taxpayers not receiving the section 45Q credit multiplier simply because they did not foresee that the facility would eventually undertake carbon capture activity. An inability to obtain the section 45Q credit multiplier will essentially put an end to investment in carbon capture projects in these situations.

Moreover, we must also point out that, although sections 45Q(h)(3) and (4) offer “cure” provisions for taxpayers who fail to meet their applicable PWA requirements and such cure provisions will presumably be mirrored in guidance under section 45Q, curing is far from a certain means of securing the section 45Q credit multiplier; it is clearly impractical in many situations and is actually impossible in situations in which the contractor responsible for constructing the facility has no contractual obligation to maintain or disclose wage and apprenticeship information to the taxpayer. Curing calls for a determination of wage underpayments and apprenticeship under-use throughout at least the period of construction, which, for large projects, will be a multi-year period and include work performed by the taxpayer as well as contractors and subcontractors. The ability of the taxpayer to obtain the information necessary to make such a determination cannot be assumed. Construction contracts for facilities with no plans for carbon capture would not contain PWA provisions requiring the contractor to retain and disclose records on wages and apprenticeship. Without such information, the cure amount simply cannot be determined.

We do not believe that the result illustrated by the above examples was the intended result of application of section 45Q(h)(2)(A) because it would make the section 45Q credit multiplier available only to those taxpayers who had the foresight and capital to make the uneconomic decision to comply with the PWA requirements with respect to the construction of a facility not expected to produce the section 45Q credit. It puts taxpayers in the position of being unable to receive the section 45Q credit multiplier even though they comply with the PWA requirements at every point in time following their decision to construct and install a completed carbon capture process chain.

Recommended Guidance

We present below three alternative suggestions for procedural guidance, any one of which could help to resolve the concern described above.

Proposed Guidance 1

Guidance could provide that if a completed carbon capture process train is not part of the original planning and design of a qualified facility, then the taxpayer will be deemed to have satisfied the requirements of section 45Q(h)(2)(A), if the taxpayer satisfies the PWA requirements with respect to the construction of the completed carbon capture process train that is installed at the qualified facility.

This proposed guidance is consistent with Rev. Rul. 2021-13, in which the IRS ruled that the 12-year production period under section 45Q begins when the completed carbon capture process train is placed in service and not at the earlier time when a component of the carbon capture equipment (that is, the AGR unit) was placed in service. Thus, under Rev. Rul. 2021-13, eligibility for the section 45Q credit is tested with respect to the completed carbon capture process train. Similarly, this proposed guidance tests a taxpayer’s eligibility for the full benefits of section 45Q by looking to satisfaction of the PWA requirements with respect to construction of the completed carbon capture process train and not any earlier activity.

This proposed guidance would also resolve the issues presented by Example A and Example B above because the taxpayer in each case would be deemed to satisfy the requirements of section 45Q(h)(2)(A) by having satisfied the PWA requirements with respect to the completed carbon capture process train. While the AGR unit in Example B is a component of carbon capture equipment under Treas. Reg. § 1.45Q-2(c)(2), the AGR unit alone does not constitute a completed carbon capture process train and so its existence would not prevent this proposed guidance from addressing the problem raised by Example B.

Although no guidance has yet been provided regarding the meaning of the term “original planning and design” as used elsewhere in section 45Q, and such guidance would certainly be helpful in this context,⁶ it would seem to be an appropriate concept to apply in the proposed guidance to resolve the inequity that would otherwise arise when an industrial facility’s original construction does not contemplate carbon capture.

Alternative Guidance 2

Alternatively, proposed guidance could interpret “qualified facility” in section 45Q(h)(2)(A) to mean “qualified facility the original planning and design of which included installation of a completed carbon capture process train.” Such an interpretation of the meaning of “qualified facility” in this context would be entirely consistent with the definition of “qualified facility” and yet would prevent application of the PWA requirements to facilities built with no intention of engaging in carbon capture. Under such guidance, if a facility does not contemplate the installation of a completed carbon capture process train in its original plan and design, section 45Q(h)(2)(A) would apply only to the subsequently constructed carbon capture process train when and if constructed. Thus, application of the PWA requirements would depend on whether the taxpayer is constructing a “qualified facility the original planning and design of which included installation of a completed carbon capture process train” or installing carbon capture equipment on a facility as to which carbon capture was not originally contemplated. Such an interpretation could be considered to be consistent with the numerous other references in section 45Q and guidance thereunder which refer to satisfaction of requirements with respect to the facility or the equipment.⁷

Alternative Guidance 3

As another alternative, proposed guidance could provide that, whether or not a completed carbon capture process train is part of the original planning and design of a qualified facility, the taxpayer will be deemed to satisfy the requirements of section 45Q(h)(2)(A) if the taxpayer satisfies the PWA requirements with respect to the construction of the completed carbon capture process train that is installed at the facility.

This proposed guidance would move the focus from whether carbon capture was in the original planning and design of the facility and would instead use satisfaction of the PWA requirements in the construction of the completed carbon capture process train as equivalent to satisfaction of the requirements as to both the qualified facility and the carbon capture equipment. Such guidance would relieve taxpayers of an obligation to comply with the PWA requirements in constructing a facility, even if such facility included carbon capture in its planning and design, as long as, when the construction of the completed carbon capture process train occurs, the PWA requirements are satisfied with respect to such construction. Such guidance would address the concern presented in both Example A and Example B since the construction of the AGR unit does not constitute construction of a completed carbon capture process train.

Request for Guidance

We believe that Treasury has been delegated sufficiently broad authority under section 45Q(h)(5) to permit issuance of any of the above-described proposals for guidance. The guidance need not take the form of section 45Q-specific guidance or regulations but could be issued in the form of a notice supplementary to Notice 2022-61 regarding the prevailing wage and apprenticeship requirements as applied to section 45Q. Regardless of the nature of the solution provided by guidance, we urge Treasury to issue such guidance as soon as possible; until it does so, taxpayers will be hesitant to move forward with carbon capture projects for those facilities that are at risk of PWA non-compliance.

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We appreciate the opportunity to submit comments and would welcome the opportunity to discuss any of these issues with you prior to the issuance of guidance.

Respectfully submitted,

By: Barbara S. de Marigny

Baker Botts LLP
Houston, TX