The U.S. Treasury Department (Treasury) and the Internal Revenue Service (the IRS) issued proposed regulations on December 22, 2023, providing initial guidance on the clean hydrogen tax credit under section 45V (the 45V Credit) of the Internal Revenue Code (the Code). Among other things, the proposed regulations:

• clarify the process for determining lifecycle greenhouse gas emissions rates that dictate 45V Credit value;
• provide rules for tying facility-specific electric generation to hydrogen production, including through new requirements for Incrementality, Temporal Matching and Deliverability (each defined and discussed below);
• establish a verification regime for taxpayers to report annual hydrogen production and sale or use;
• provide mechanics for taxpayers electing to claim an investment tax credit (ITC) in lieu of 45V Credits, including the mechanics for ITC recapture; and
• make numerous other clarifications as described below.

The Treasury and the IRS have requested comments on multiple specific items. In general, the requests suggest a willingness to consider alternative rules provided that doing so does not sacrifice the government’s ability to verify 45V Credit eligibility or encourage hydrogen production that is wasteful or at emissions levels that are greater than those allowed by statute. The IRS will collect comments until February 26, 2024, and will hold a public hearing on March 25, 2024.

The proposed regulations are binding on the IRS until they are either amended or superseded by final published regulations. Although the proposed regulations do not have the force of law unless and until they are adopted as final, taxpayers may rely on them now if applied in their entirety and in a consistent manner.

The proposed regulations were highly anticipated by global market participants, as the 45V Credit is understood to have wide-ranging implications for the feasibility and compatibility of U.S. hydrogen projects within the emerging national and international hydrogen markets. The requirements for hydrogen under the European Union’s renewable energy directive and certain delegated acts by the European Commission (collectively, the EU Hydrogen Rules) recently completed a similar promulgation process. The EU Hydrogen Rules are relevant not only for hydrogen production in the European Union (the EU), but also for hydrogen and hydrogen derivatives expected to be exported to the EU. You can find our latest publications on the development of the EU Hydrogen Rules, here.

Below is a more detailed summary of the key provisions in the proposed regulations as well as our initial observations. We have included comparisons to the EU Hydrogen Rules where relevant, and have also included resources from the A&O team on global hydrogen markets as additional background.

Background on the 45V Credit

• The 45V Credit is a production-based tax credit determined according to the amount of qualifying hydrogen the owner of a hydrogen facility produces and sells or uses during the 10-year period beginning when the hydrogen facility is placed in service. The production and sale or use must be verified by an accredited third party verifier.
• Facilities eligible for the credit must generally be placed in service after December 31, 2022, and have begun construction before January 1, 2033.
• The hydrogen production must take place in the United States (though the “sale or use” may take place outside of the United States) and meet certain lifecycle emissions requirements described below.
• As illustrated below, the 45V Credit amount is determined each year by first multiplying the kg of qualifying hydrogen produced during the year by the applicable credit rate ($0.60/kg or $3.00/kg if the facility either began construction before January 29, 2023, or meets the prevailing wage and apprenticeship requirements),¹ and then multiplying that number by an applicable percentage based on the lifecycle greenhouse gas emissions rate of the hydrogen production process. “Qualified clean hydrogen” eligible for the 45V Credit must be produced through a process that results in a lifecycle greenhouse gas emissions rate of not greater than 4kg of CO2e per kg of hydrogen. Emissions rates between 4kg and 0.45kg of CO2e per 1kg of hydrogen produced qualify for 45V Credits at a reduced amount.
• As an alternative to claiming the production-based credit, taxpayers can elect to claim an ITC worth 6% of a taxpayer’s eligible basis in the hydrogen production facility (or 30%, if the facility either began construction before January 29, 2023, or meets the prevailing wage and apprenticeship requirements), subject to a similar adjustment based on the lifecycle greenhouse gas emissions rate applicable to the hydrogen production process.

• Rather than claiming credits directly (or monetizing them with tax equity), facility owners can opt to apply the credits as a payment against tax (generally referred to as “direct pay”) for the first five years of the 10-year 45V Credit period, or sell them to third parties under the “transferability” provisions of the Code.

The proposed regulations

Clarity on process for determining lifecycle greenhouse gas emissions rates

• The proposed regulations define “lifecycle greenhouse gas emissions” as including emissions only through the point of production (well-to-gate), as determined under the most recent Greenhouse gasses, Regulated Emissions, and Energy use in Transportation model (the GREET model).
  • This includes emissions associated with feedstock growth, gathering, extraction, processing, and delivery to a hydrogen facility, as well as emissions associated with the hydrogen production process, including electricity used by the facility and any equipment for capture and sequestration of carbon dioxide generated by the facility.
• Taxpayers must use the most recent GREET model to determine the lifecycle greenhouse gas emissions rate for each qualifying hydrogen facility and for each taxable year during the 45V Credit period.

• The relevant GREET model is the latest publicly available version of 45VH2-GREET developed by Argonne National Laboratory on the first day of the year during which the hydrogen for which the taxpayer is claiming the 45V Credit is produced. If a new version becomes available later in the taxable year, then the taxpayer may use the newer version instead.
• The GREET model incorporates certain fixed assumptions or “background data,” such as upstream methane loss rates and the emissions associated with regional electricity grids. Taxpayers will fill in the non-fixed inputs to determine the emissions rate.

Observation: The fixed inputs in the GREET model are intended to represent parameters that are difficult for hydrogen producers to independently verify. Treasury and the IRS are asking for public comment on how verifiable these inputs are in the event future releases change them to manual inputs. They also request comments on the allocation mechanism for co-products produced alongside hydrogen, including restrictions on steam, which are meant to prevent taxpayers from inflating the 45V Credit amount by artificially reducing hydrogen production’s carbon intensity through the overproduction of steam and other co-products.

• As of the release date of the proposed regulations, the GREET model allows for eight different production pathways, several of which involve carbon capture and sequestration.

Observation: Treasury and the IRS recognize that the GREET model will need periodic updating, including for feedback from public comments on the proposed regulations. For example, the current version does not include every possible biomass fuel as a feedstock or all pathways that are currently in use or that could become commercially viable in the future.

• Taxpayers using a feedstock or hydrogen production technology that is not contemplated in the most recent GREET model (e.g., geologic hydrogen or trigeneration) can submit a “provisional emissions rate” (a PER) petition with their federal income tax return for the first taxable year to which the petition relates.
• The petition must include an emissions value provided to the taxpayer by the Department of Energy (the DOE) setting forth the DOE’s assessment of the lifecycle greenhouse gas emissions for the production pathway.
  • The emissions value request process will open on April 1, 2024, and will use procedures specified by the DOE.
  • The process is only open to mature projects – i.e., those having performed a front-end engineering and design (FEED) study or of a similar level of maturity. The DOE’s forthcoming procedures are expected to address this requirement in more detail.
• PER petitions will be deemed approved upon the acceptance of the federal income tax return by the IRS, enabling the taxpayer to rely on the DOE’s emissions value determination for purposes of calculating 45V Credits.

Requirements for tying facility-specific electric generation to hydrogen production

• Taxpayers wishing to tie the source of a hydrogen facility’s electricity to a specific generating facility (as opposed to the regional electricity grid generally) for purposes of the GREET model or a PER must acquire and retire qualifying “energy attribute certificates” (EACs) that match the electricity from the generating facility.
  • EACs are tradeable contractual instruments issued through a registry or similar accounting system representing a specific unit of energy from a specific facility. Renewable energy certificates are a form of EAC.
  • EACs are required for all projects, even where the electric generating facility is directly connected to or co-located with the hydrogen facility.
• To qualify for GREET model or PER purposes, an EAC must include certain identifying information about the source facility, receive third party verification under the rules described below, and satisfy the Incrementality, Temporal Matching and Deliverability requirements described below.
• “Incrementality” means:
  • the generating facility achieved its commercial operation date not more than 36 months before the hydrogen facility was placed in service, or
  • the electricity relates to an increase in generating capacity that occurred not more than 36 months before the hydrogen facility was placed in service, and the electricity is attributable to such increased capacity.

Observation: The Incrementality requirement could prevent hydrogen facilities that would otherwise meet emissions rate requirements from qualifying simply because the source facility is over three years old. This is a particularly disappointing result for existing nuclear generating facilities which would have had an opportunity to sell power to new hydrogen facilities. In recognition of this issue, Treasury and the IRS noted that they are considering – and have requested comments on – the following three alternative approaches: (i) an avoided retirement approach that would treat EACs from an existing facility as satisfying Incrementality if the facility is likely to avoid retirement because of its relationship with a hydrogen production facility; (ii) a modeling approach if able to demonstrate zero or minimal grid emissions notwithstanding a commercial operation date of greater than 36 months; and (iii) a safe harbor approach that would allow five percent of electricity from existing facilities as satisfying Incrementality.

EU Insight: In contrast to what some market participants had anticipated, the proposed regulations do not precisely copy the “additionality” concept set forth in the EU Hydrogen Rules. The key distinction is that the proposed regulations do not limit the ability of the electricity generation facility to receive subsidies, e.g., in the form of tax credits, whereas the EU Hydrogen Rules will. The EU Hydrogen Rules generally forbid payments of state aid to the electricity generation facility.

• “Temporal Matching” means:
  • Before January 1, 2028, that the electricity represented by the EAC is generated in the same calendar year that the hydrogen facility uses the electricity to produce hydrogen, or
  • On or after January 1, 2028, that the electricity represented by the EAC is generated in the same hour that the hydrogen facility uses the electricity to produce hydrogen.

Observation: The hourly Temporal Matching requirement that begins in 2028 appears driven by advice from the DOE to Treasury and the IRS that hourly matching is necessary to verify the accuracy of electric generation sources; however, Treasury and the IRS also recognize that hourly matching is not currently possible because reliable tracking systems do not yet exist. The pre-2028 calendar year matching is intended as a transition rule to buy time for the EAC market to develop the necessary tracking capability. Nevertheless, the uncertainty surrounding the implementation of the hourly matching regime could potentially delay or reduce investment capital into hydrogen projects.

Observation: It is not clear how hourly matching will work for purposes of the Temporal Matching requirement in cases where hydrogen is immediately stored for later sale or use.

EU Insight: The EU Hydrogen Rules require hydrogen production to meet an hourly matching requirement as well. However, market participants in the EU have until 2030 to prepare for the application of the hourly matching rules. Until then, the EU Hydrogen Rules require a monthly matching of electricity generation and hydrogen production. The proposed regulations are more generous in this regard because they allow for an annual matching of electricity generation and hydrogen production in the U.S. through 2027.

“Deliverability” means that the electric generating facility is in the same transmission region as the hydrogen production facility, as illustrated below.²

Observation: A hydrogen facility would fail the Deliverability requirement if its electricity source is located in a different region, even if they are in close proximity to each other. As with the other requirements, Treasury and the IRS have requested comments on whether there are alternative ways to establish the deliverability of electricity to a hydrogen facility even if the generating facility is not in the same region or is outside of the United States.

EU Insight: The Deliverability requirement is quite similar to the “geographical correlation” under the EU Hydrogen Rules, which require the hydrogen and electricity to be provided in the same (or interconnected) “bidding zones” (which roughly translate to the concept of ‘transmission region’ in the U.S.). The EU Hydrogen Rules explicitly apply to hydrogen and derivatives imports but the EU Commission acknowledges that such rules must be adapted to the region of production. That should be the case for bidding zones and transmission regions (subject to technical confirmation).

Annual verification reporting requirements

• Taxpayers must attach verification reports to their federal income tax returns for each facility that produces qualifying hydrogen and for each year in which they claim 45V Credits.
  • Verification reports are required to be signed by the due date (including extensions) of the federal income tax return for the taxable year in which the hydrogen undergoing verification is produced (except in cases where a credit is first claimed on an amended return or administrative adjustment request).

Observation: The 45V Credit arises during the year in which the hydrogen is produced, regardless of whether the hydrogen is used or sold in a subsequent year. However, taxpayers cannot claim a 45V Credit without a verification report. If the verification occurs after the extended due date of the tax return for the year, then the taxpayer would need to file an amended return or administrative adjustment request (in the case of a partnership) to include the verification. The IRS has requested comments on whether an extended tax return filing deadline is enough time to complete the verification.

• Reports must be prepared by a “qualified verifier” and signed under penalty of perjury.
  • “Qualified verifiers” must certify as to their independence from the taxpayer and the transaction (and to any purchaser of 45V Credits under the “transferability” rules of section 6418 of the Code), and have an active accreditation from the American National Standards Institute National Accreditation Board or the California Air Resources Board Low Carbon Fuel Standard program.
• The content of the reports must include the following:
  • an attestation regarding the taxpayer’s production of qualified clean hydrogen during the taxable year;
  • an attestation regarding the amount of hydrogen sold or used;
  • an attestation confirming that the verifier does not have a conflict of interest;
  • documentation of the verifier’s qualifications;
  • certain general information about the hydrogen facility; and
  • any other documentation necessary to substantiate the verification process according to best practices of the verifier’s accrediting body and the circumstances of the taxpayer and the facility.

Observation: Annual verification reports require significant detail, reflecting a focus of Treasury and the IRS on preventing abuse and the wasteful production of hydrogen (e.g., for venting or flaring).

EU Insight: It is noteworthy that the proposed regulations’ threshold of 4 kg of CO2e per kg of hydrogen is more generous than the threshold applied by the EU Hydrogen Rules. In the EU, the carbon intensity of green hydrogen and its derivatives must not be greater than 28.2 gCO2e/MJ, which according to technical experts amounts to 3.4 kg of CO2e/kg of hydrogen. However, there are variances in the methodologies to be applied when calculating the relevant CO2 equivalents and the overall approach to life-cycle assessments on both sides of the Atlantic, and a thorough analysis of the carbon intensity of the respective hydrogen production process will be a key factor for the economic viability and compatibility of hydrogen projects in the U.S. and the EU.

Clarifications for hydrogen facilities electing the ITC

• The rules described above for the 45V Credit generally still apply, including the requirement for verification reports (but only for five years in the case of ITC projects).
• ITC election must be made on a timely filed tax return for the year the facility is placed in service, is irrevocable, and is binding on all taxpayers with a direct or indirect ownership interest in any part of the facility.

Observation: Treasury and the IRS have asked for comments on whether taxpayers should be able to make separate elections for a facility owned in a tenancy in common arrangement or by a partnership that elects out of the partnership tax rules according to the taxpayers’ proportionate ownership.

• ITCs are subject to recapture during each year of the five-year period beginning on the date the facility is placed in service.
  • 20% of the ITCs are subject to recapture in each year during the five-year recapture period for failing to obtain an annual verification report or if annual production exceeds a lifecycle greenhouse gas emissions rate of greater than 4 kg of CO2e per kg of hydrogen.
  • ITCs are subject to partial recapture (not to exceed 20%) if in any year during the recapture period the actual lifecycle greenhouse gas emissions rate would have resulted in a lower tier of ITC than was claimed when the facility was placed in service.
  • ITCs are also subject to recapture for reasons unrelated to hydrogen production, such as project dispositions and failure to satisfy the prevailing wage and apprenticeship requirements during the recapture period.

Observation: Hydrogen facilities electing into the ITC regime cannot become eligible for “tax credit adders” for projects in energy communities or that meet domestic content requirements. Hydrogen projects are ineligible for adders irrespective of whether the owner claims 45V Credits or ITCs.

Other clarifications

• Each “qualified facility” includes a single production line that is used to produce qualified clean hydrogen, including all components of property that function interdependently to produce qualified clean hydrogen.
  • Multipurpose components (i.e., that have a purpose in addition to hydrogen production) may be part of a facility if such components are necessary to produce hydrogen that qualifies for the 45V Credit.
  • The definition excludes equipment used to (i) condition or transport hydrogen beyond the point of production, or (ii) produce electricity to power the hydrogen production process, including any carbon capture equipment associated with the electricity production process.

Observation: The proposed regulations provide an example of a facility that cannot produce qualifying clean hydrogen without carbon capture equipment, which causes the carbon capture equipment to be treated as interdependent with other components so that it is treated as part of the hydrogen facility. Given the general exclusion of carbon capture equipment associated with the electricity production process, the example suggests that carbon capture equipment is only part of a hydrogen facility if needed to achieve a qualifying emissions rate.

• The “sale or use” of hydrogen does not have to be immediate; hydrogen can be produced and stored so long as it is ultimately sold or used.

Observation: It is not clear how hourly matching will work for purposes of the Temporal Matching requirement in cases where hydrogen is immediately stored.

• Facilities placed in service that are ineligible for the 45V Credit (e.g., because they were placed in service before January 1, 2023, and do not produce qualifying hydrogen) can become eligible if modified to produce qualifying hydrogen.
• Existing hydrogen facilities can also be treated as newly placed in service if retrofitted with equipment representing at least 80% of the facility’s total value, taking the cost of the used equipment into account (the 80/20 Rule).
• Carbon capture equipment with respect to which a tax credit was claimed under section 45Q of the Code (which would generally render a hydrogen facility that includes such carbon capture equipment ineligible for the 45V Credit) that is retrofitted under the 80/20 Rule can be treated as property for which the 45Q credit was not previously allowed, making any associated hydrogen facility eligible for the 45V Credit.
• The proposed regulations include an anti-abuse rule under which the 45V Credit is disallowed if the primary purpose of the production and sale or use of the qualifying hydrogen is to obtain the benefit of the 45V Credit in a manner that is wasteful, such as the production of hydrogen that the taxpayer knows or has reason to know will be vented, flared, or used to produce excess hydrogen. The determination is made based on the facts and circumstances.

Observation: The IRS and Treasury are concerned with abusive schemes to claim the 45V Credit in a manner that is contrary the tax credit’s purpose of providing an incentive to produce clean hydrogen for productive use. It is unclear how liberally the IRS would apply the anti-abuse rule beyond clearly fraudulent cases, and whether it imposes some form of duty on the hydrogen producer to ask the offtaker about its intentions.

Additional A&O resources on global hydrogen markets

The interplay between the proposed regulations and analogous rules in major import markets such as the European Union and Japan will become ever more important as hydrogen projects in the U.S. start to compete for offtake contracts. At the same time hydrogen exporters in the Middle East and Australia are preparing to deliver to these markets as well. Managing the remaining regulatory uncertainty both in the national and the international context is a key consideration for the successful development of U.S. hydrogen projects. For readers who are newer to the discussions regarding the regulatory treatment of hydrogen and its derivatives around the globe, key articles written by the A&O team may be found below.

Footnotes

1. The prevailing wage and apprenticeship requirements are described in detail at the following link: https://www.allenovery.com/en-gb/global/news-and-insights/publications/navigating-treasurys-proposed-regulations-on-prevailing-wage-and-apprenticeship-for-clean-energy-projects. The credit rate is adjusted annually for inflation.
2. Regions for purposes of the Deliverability Requirement are derived from the National Transmission Needs Study that was released by the DOE on October 30, 2023 and is available at https://www.energy.gov/sites/default/files/2023-10/National_Transmission_Needs_Study_2023.pdf.