backOn August 16, 2022, President Biden signed the Inflation Reduction Act of 2022 (the Act). The Act includes multiple tax benefits for hydrogen production, storage and utilization, summarized in the following King & Spalding Client Alert.
This H2ypothetical is the third in our series designed to provide our observations on the Act’s hydrogen related provisions. Understanding these rules will take time and hopefully many of the ambiguities we see will be resolved by government guidance. In the meantime, these H2ypotheticals will hopefully answer some basic questions and tease out some issues that need guidance to resolve.
HYPOTHETICAL
Taxpayer owns and operates a solar or wind farm that is eligible for either the Section 45 production tax credit (PTC) or the Section 48 investment tax credit (ITC). The taxpayer has installed equipment to generate “clean hydrogen” and store it.
The taxpayer purchases ten fuel cells to generate electricity using the clean hydrogen it generates. Fuel cells generate electricity by drawing in oxygen from the atmosphere and combining it with stored hydrogen and through a catalytic process generates electricity, water and a little heat. The catalyst portion of the fuel cell is referred to as the stack assembly and the remaining components necessary to convert hydrogen into electricity are commonly referred to as the “balance of plant”.
Each fuel cell has a capacity of 100 kilowatts and has an electricity only generating efficiency of at least 50%. The fuel cell stack was manufactured in Europe and the remaining balance of plant was manufactured in the United States. Final assembly of the fuel cell power plant occurred in the United States.
The fuel cells will be “placed in service” in 2023 and located next to the solar/wind farm within the United States. The electricity will be sold to third parties during times when the solar/wind farm is not producing enough electricity.
Fuel Cell ITC
Fuel cells are a separate category of ITC eligible “energy property” under Section 48. A “hydrogen fuel cell power plant” eligible for the credit must have a nameplate capacity of at least 0.5 kilowatts (500 Watts) and an electricity-only generation efficiency of greater than 30 percent.1IRS Notice 2008-69, 2008-24 I.R.B. 418 provides definitions for “nameplate capacity” and “generation efficiency” with a general delegation to the manufacturer to determine capacity and ANSI/ASME standards to determine efficiency. These conditions should be easily satisfied in most commercial scale fuel cell applications. The “balance of plant” equipment does not have minimum standard requirements like the capacity/efficiency standards required of the fuel cell.2Balance of plant must be “integral” to the fuel cell system. See RP1 Fuel Cell, LLC v. United States, 120 Fed. Cl. 288 (2015), aff’d 644 Fed. Appx. 1012 (Fed. Cir. 2016) for a lengthy discussion of whether gas conditioning equipment can be integral to fuel cell property and thus eligible for the ITC.
The Act places the fuel cell ITC on the same base rate (6%) and subject to the multiplier factors available for other Section 48 credits. This means that the maximum ITC available can be 30, 40 or even 50% depending on satisfying the relative multipliers. However, fuel cell property is subject to an overall cap of $1,500 for each 500 Watts of capacity ($3,000 per kW). This means that a 100 kW fuel cell should be entitled to a maximum credit of $300,000.
ITC eligible projects are entitled to the initial 30% rate if it satisfies or is deemed to satisfy the minimum wage and apprenticeship requirements. A project is deemed to satisfy the standards if: 1) it has a maximum net output of less than one Megawatt (1,000 kW) measured using alternating current, or 2) it begins construction before the date that is 60 days after guidance regarding the prevailing wage/apprenticeship requirements are published. An “energy project” includes one or more energy projects forming part of a “single project”. We expect existing guidance regarding when properties are grouped together to establish when construction began to be used as a basis for grouping projects together for this purpose.
Under our H2ypothetical’s facts, the total maximum output for the fuel cells (assuming the rating is in alternating current) equals 1 Megawatt. The project should not be deemed eligible based on its aggregate capacity. However, it might be deemed to comply if construction begins before the 60 day deadline after the prevailing wage/apprenticeship rules are published. Even in that event, the prevailing wage concept should apply to certain alterations or repairs occurring within the five year period beginning on the date the project is placed in service.
The fuel cells may be eligible for the 10-percentage point domestic content bonus ITC even though the stack was manufactured in Europe. The requirements are embedded in the PTC rules (Section 45) and will be covered in more detail by a future H2ypothetical but, aside from steel and iron, the minimum domestic content percentage should be 40%. We expect (and hope) that Treasury/IRS guidance to treat the fuel cell and balance of plant as a single unit for purposes of applying this rule.
The fuel cells may be eligible for the 10-percentage point “energy community” bonus ITC if the project is located within a qualifying community. The energy community concept will be covered in more detail by a future H2ypothetical.
In summary, the taxpayer’s fuel cells may be eligible for an ITC of up to 50% subject to the overall per kW capacity cap. There are several areas where Treasury/IRS guidance will be critical in evaluating the overall maximum ITC potential for the project however.
Interaction with Other Rules
In our hypothetical the fuel cell provides the next link in the hydrogen value chain, allowing the green hydrogen to be converted into electricity. Electricity generated by the fuel cell does not appear to qualify for the current PTC because it is not listed as a “qualified energy resource” by Section 45(c). Facilities placed in service from January 1, 2025 may be eligible for the Section 45Y clean electricity PTC (covered in a future H2ypothetical). The new Section 48E that will supplant the Section 48 ITC for fuel cell property does not have this limitation but it has the same effective date as Section 45Y and is of no help until then.
The fuel cell ITC’s effective $3,000 per kW cap on ITCs could pose a problem. Even with bonus credits a facility’s eligible costs may not hit this overall cap. However, this answer may dramatically change if the hydrogen storage equipment co-located with the fuel cells are included as integral property. Both are generally ITC eligible under our facts, but if even some of the commercial scale hydrogen storage is treated as an integral part of the fuel cell’s balance of plant this could limit the availability of the new “stand alone” storage credit.
This point highlights a continuing tension regarding when property is separate for purposes applying the various beneficial tax credit provisions. Prior to the Act, there was often an incentive to bundle as many assets as possible into a single “energy property” or facility definition. Now the opposite may be the case.
The better answer for taxpayers (and the environment) is to treat storage as independent of the fuel cell property to avoid this $3,000 per kW cap. This is not a short-lived problem that falls away for projects placed in service beginning in 2025 as the bundling or unbundling of property for tax credit purposes has multiple applications, some of which will be covered in future H2ypotheticals.
Treasury guidance will hopefully resolve this issue in taxpayers’ favor soon.
TAKEAWAYS
Fuel cell technology is a critical element in promoting the generation and deployment of green hydrogen. Extension and expansion of the ITC for this vital equipment is a welcome addition to the Act. However, Treasury needs to quickly address many critical questions regarding the scope of the ITC in this context.
For purposes of discussion, the fact patterns described above have been considerably simplified and many simplifying assumptions have been made. Readers should not construe the contents of this Hypothetical as legal, tax or other advice, and should consult their own tax or legal advisor as to legal, tax and other related matters concerning the Act.