The pursuit of hydrogen, and in particular green hydrogen, projects is becoming a key focus of achieving Australia's net zero emissions targets and our push to a clean energy future.
Australia's national Hydrogen Strategy makes clear that substantial private capital will be needed to progress the development of green hydrogen projects and, like in other infrastructure sectors, it is likely that large portions of that capital will come from offshore institutional investors.
However, the path set out in the strategy of developing small pilot projects before building scale over time doesn’t fit neatly with the tax concessions available for foreign investors in 'approved economic infrastructure projects' – so it seems to be another case of current tax policy running behind changes in broader energy policies and creating an opportunity for reform.
The Commonwealth Chief Scientist released Australia’s Hydrogen Strategy in 2019. This plan canvassed how the nation could become a renewable energy superpower, by harnessing the most abundant element in the universe.
The industrialisation and commercialisation of hydrogen, which the Strategy expects to rapidly progress in the coming decades, will be predominantly undertaken by private enterprise with the assistance of Government support and policy. It starts with a focus on small pilot projects, typically with a single offtake agreement, to prove out an investment thesis before progressing to larger investment.
The nature of the industry and the methods used to create and market the new clean hydrogen fuel means that hydrogen projects may struggle to meet the Economic Infrastructure requirements to benefit from concessional rates of withholding for foreign investors. We briefly provide a background to the development and strategy behind the new industry below, and the potential tax incentives and regimes available for private enterprise to harness the capability in future.
What is hydrogen?
Hydrogen is the most abundant element in the universe, predominantly existing as H2 gas. H2 gas can be burned with oxygen to produce energy and water.
Presently, fossil fuels (predominantly oil, gas and coal), are the world's primary combustion fuels, used to power motor vehicles, power stations and other vital processes, such as steelmaking.
In future, hydrogen may replace fossil fuels for these processes as technology develops. However, hydrogen must be produced, rather than mined. The most accessible means of production is electrolysis; using electricity to split water (H2O) into hydrogen (H2) and oxygen (O2).
Once produced, hydrogen may be stored as a gas or liquid, or converted into other chemicals (such as ammonia – NH3). Hydrogen fuels could power the vital processes for which we currently use hydrocarbons, without the resulting greenhouse gas emissions such as CO2. This may include replacing coking coal in blast furnaces in the steelmaking process.
However, technology for the production and storage of hydrogen fuels, and for safe and cost-effective transportation of those fuels, is not at an industrialised or commercialised stage. Even where hydrogen technology is well-established (e.g., hydrogen fuel cells or electrolysis plants), worldwide production and scale does not exist to support an "economy".
What is "green hydrogen"?
The production of hydrogen fuel requires significant energy.
Green hydrogen denotes the production of hydrogen fuel solely through the use of renewable resources. Most commonly, this involves electrolysis with the use of solar, wind or hydroelectric power.
Once clean hydrogen fuel is stored, its use will not produce greenhouse gas emissions. This is unlike other methods, such as electrolysis powered by fossil fuels and carbon sequestration and storage (CCS), which inevitably leads to leakage of greenhouse gases into the atmosphere.
The Hydrogen Strategy
The Hydrogen Strategy proposes an "adaptive pathway" to clean hydrogen growth. This pathway includes four underpinning principles:
Taking an adaptive and nationally-coordinated approach to support industry development
Prioritising regulatory consistency and a coordinated approach to project approvals
Support partnerships to activate the market
Put safety, environmental sustainability and benefits to Australians at the forefront.
A taxation and investment strategy
A key driver for the adoption of hydrogen and its progression to an alternative energy source will be any financial incentives available to industry and investors.
Australia's Hydrogen Strategy focuses on the potential for an export industry, while some consideration is given to heavy-duty and long-distance transport, and the large scale production of ammonia.
The World Energy Council notes several key policy tools for governments to facilitate the development of the hydrogen economy:
Direct financial support for hydrogen production capacity and R&D projects (which would likely be directed at activities such as hydrogen fuel storage and transportation, activities still requiring commercialisation).
Mobilising private funding – incentives that promote private investment in businesses and assets forming part of the potential hydrogen economy.
Financial incentives, including:
a. Tax policies such as carbon pricing and carbon taxes (e.g., Norway), which may cause the relative cost of hydrogen as an alternative fuel to decrease in comparison to fossil fuel substitutes such as hydrocarbons.
b. Reducing taxes for hydrogen fuels (e.g., road tolls, ferry charges, parking fees, exempting producers from electricity levies) – similarly, making hydrogen fuels more competitive.
c. Subsidies – where electricity used for hydrogen production is promoted through a purchase mechanism.
Current Australian measures available
The Hydrogen Strategy notes that hydrogen is not explicitly considered as an energy source in Australia's existing tax and excise regulation framework (including the Petroleum Resource Rent Tax or PRRT). This could also result in hydrogen not yet falling within the Energy Infrastructure framework within the staples rules. The Strategy notes that Australia will continue with the revenue arrangements that currently apply to hydrogen, but may consult industry and the community before making any specific changes.
Existing tax incentives and regimes which may apply to businesses engaging in the hydrogen economy may include:
(a) Government grants
The Commonwealth and certain State Governments may offer grant money and co-investment support to businesses investing in hydrogen production, R&D or fuel cell activities. The Commonwealth will do this through ARENA – a government agency established for the purpose of funding renewable energy projects. NSW, Queensland and Western Australia are probably the most advanced of the States in terms of policies involving hydrogen hubs and projects (and related support).
Generally, government grants to assist businesses to continue operating may be viewed by the Commissioner as assessable income, and (for corporate entities) may be taxed at the 30% corporate tax rate. Grants to establish a new business may be taxed more concessionally, but this needs to be considered on a project-by-project basis.
It is important to consider the legal form and substance of these arrangements when commencing operations, to ensure the full benefit of any grant money is realised.
Typically there are restrictions on how grant money is used and it may be necessary to equity or debt fund amounts for the payment of taxes.
(b) The R&D Tax Incentive Regime
Companies that directly engage in R&D activities in Australia may be able to access the R&D tax incentive regime, which provides a tax offset for a company's R&D expenditure.
For larger entities (with a turnover above $20 million) the offset amount will depend on whether the company's R&D "intensity", being the proportion of their R&D expenditure compared to their total annual expenditure, is above or below 2%.
To access the incentive, a company must make sure:
it is an eligible entity;
the activity undertaken is an eligible "core" R&D activity;
all R&D activities are registered with the Department of Industry, Science, Energy and Resources; and
it complies with reporting and documentation requirements.
Given the complexity of the rules governing eligible R&D activities, it is recommended that companies seek advice when applying for the R&D Tax Incentive.
(c) Investment - MIT economic infrastructure regime
The Australian Managed Investment Trust (MIT) regime provided a lower (15%) withholding tax rate to foreign investors from 'exchange of information' countries on distributions made by certain types of trusts. Effectively, the regime increases the attractiveness of investing in certain types of managed funds which involve the derivation of passive income. Previously, this concession was available for land-intensive infrastructure projects through the use of a stapled structure, however legislative changes announced in 2018 and implemented in 2019 have limited the ability to access the concessional tax rates for stapled structures going forward.
Essentially, new infrastructure staples can only benefit from the reduced withholding tax rate (a) for a limited period of 15 years and (b) where the project qualifies as an "approved economic infrastructure facility" which requires, among other things, capital expenditure to build or expand the project of at least $500 million and approval by the Treasurer.
"Economic infrastructure" is not a defined term in Tax Legislation, however, explanatory materials for the legislative changes to the MIT regime provide that economic infrastructure facilities are "enduring facilities that support or enable economic activity and improve national productivity in Australia". This is specified to include:
Communications infrastructure; and
In theory, projects or businesses in the hydrogen economy may be able to access this measure, to increase attractiveness to investors (for example, for renewable energy projects which generate electricity for hydrogen electrolysis and production). However, the current strategy, under which pilot projects are run in order to build an investment thesis prior to larger scale production commencing, will likely mean that hydrogen projects will fall outside the "approved economic infrastructure facility" concept: the pilot plants will be too small to qualify and the future expansions may well fall outside the "yet to be constructed" criteria. Although it is noted that a large scale expansion project may fit within the rules provided it is deemed to be "Energy Infrastructure" or falls within another category.
(d) On the horizon - Patent Box
In the 2021-22 Federal Budget, the Government announced it will establish a patent box regime in Australia for certain income generated from Australian medical and biotechnology patents. The regime would apply a 17% concessional corporate tax rate for income derived directly from new patents granted after 1 July 2022 (subject to the legislation).
Treasury announced it will consult with industry to determine whether the concessional treatment may be extended to patents in the clean energy sector.
Notwithstanding the possible extension to clean energy, it should be noted that patent development and status may not be readily accessible activities undertaken in the future hydrogen economy, and the benefits of a patent box may not be realised in the key stages of development.
(e) International mechanisms
Several countries, including the European Union, have announced climate and trade policies that may consider Scope 1, 2 and 3 emissions in "border adjustments" or levies on import (if introduced).
Essentially, a border adjustment levy (where widely introduced globally) may increase the relative price of imports in affected countries, from countries where carbon pricing is absent, and greenhouse gas emissions connected to those imports are higher.
If mechanisms such as this are introduced globally, the relative price of emerging green technologies, such as hydrogen fuels (and refined iron ore or steel manufactured using green hydrogen technology), may become more competitive with existing technologies such as natural gas and steel refined using coking coal.
Following the COP26 Global Climate Summit held in November 2021, the EU has announced it may implement a border adjustment levy unilaterally. Alternatively, a more global mechanism to price carbon into international trade may arise.