26 May 2025 External T.I. 2025-1056481E5 - Clean Hydrogen ITC: Electrolysis of Water

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: 1. Does the electrolysis of water include the chlor-alkali process? 2. Does the electrolysis of water include the chlorate process?

Position: 1. No. 2. No.

Reasons: The conclusions are based on a textual, contextual and purposive interpretation of the phrase "electrolysis of water" within the clean hydrogen ITC legislation.

XXXXXXXXXX								Nicki Verlinden
									2025-105648

May 26, 2025

Dear XXXXXXXXXX,

Re: Meaning of “electrolysis of water” for purposes of the Clean Hydrogen Investment Tax Credit (“CH ITC”)

You asked us to interpret the term “electrolysis of water” as it is used in the definition of eligible pathway in subsection 127.48(1) of the Income Tax Act (footnote 1) (“Act”). The specific issue considered in this letter is whether (i) the chlor-alkali process and (ii) the chlorate process have the same meaning as “electrolysis of water” and are therefore considered to be eligible pathways for purposes of claiming the CH ITC.

OUR COMMENTS

This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R12, Advance Income Tax Rulings and Technical Interpretations.

Unless otherwise stated, all references to a statute are to the relevant provision of the Act.

A. Background

The CH ITC is a refundable investment tax credit that supports the cost of eligible equipment used in eligible clean hydrogen production projects. The credit rate varies between 15 to 40 per cent of eligible expenses based on the hydrogen's assessed carbon intensity, with projects that produce the cleanest hydrogen receiving the highest levels of support.

In the Tax Supplementary document to Budget 2023, it states:

Only projects that produce all, or substantially all, hydrogen through their production process would be eligible for the CH Tax Credit (determined without reference to any produced CO2 that is captured and stored or used, or excess electricity that may be sold to the electricity grid). (footnote 2)

B. Relevant excerpts from the CH ITC legislation

The clean hydrogen tax credit of a qualifying taxpayer (footnote 3) for a taxation year means

(a) the total of all amounts each of which is the specified percentage of the capital cost to the taxpayer of an eligible clean hydrogen property that is acquired by the taxpayer in the year; […] (footnote 4)

Eligible clean hydrogen property is also defined in subsection 127.48(1). The relevant portion of this definition is copied below:

eligible clean hydrogen property means property, other than excluded property, that

(a) is acquired by a qualifying taxpayer and becomes available for use in respect of a qualified clean hydrogen project of the taxpayer in Canada on or after March 28, 2023, determined without reference to subsection (5);

(b) has not been used, or acquired for use or lease, by any person or partnership for any purpose whatever before it was acquired by the taxpayer; and

(c) is property situated in Canada

(i) that is used all or substantially all to produce hydrogen through electrolysis of water, including electrolysers, rectifiers, purification equipment, water treatment and conditioning equipment and equipment used for hydrogen compression and storage, […]

On August 12, 2024, draft legislation modifying the above definition was released in order to clarify that the property described above must be used to produce all or substantially all hydrogen. (footnote 5)

Qualified clean hydrogen project is also defined in subsection 127.48(1). The relevant portion of that definition is:

qualified clean hydrogen project means a clean hydrogen project of a taxpayer, as described in the taxpayer's clean hydrogen project plan, where the Minister of Natural Resources has confirmed in writing that

(a) the hydrogen will be produced from an eligible pathway; […]

Eligible pathway is also defined in subsection 127.48(1). It states:

eligible pathway means the production of hydrogen

(a) from electrolysis of water; or

(b) from the reforming or partial oxidation of eligible hydrocarbons, with carbon dioxide captured using a CCUS process. (footnote 6)

The explanatory notes to the definition of eligible pathway confirm that producing hydrogen from an eligible pathway is a required condition for a clean hydrogen project to become a "qualified clean hydrogen project". (footnote 7)

Therefore, if the chlor-alkali process is not the electrolysis of water, then it is not an eligible pathway. Similarly, if the chlorate process is not the electrolysis of water, then it is also not an eligible pathway. Consequently, the equipment used in those processes will not qualify for the CH ITC.

C. Electrolysis of water

The term “electrolysis of water” is not defined in the Act. Furthermore, this term is not used in common parlance and it is not defined in the Oxford English Dictionary. It does however have a generally accepted industrial/scientific meaning, which is referred to as a “technical term” in the text Essentials of Canadian Law: Statutory Interpretation. (footnote 8)

Where legislation uses a technical term (also, commonly referred to as “a term of art”), that term- in effect - constitutes the ordinary meaning that is to be considered when undertaking a textual, contextual and purposive interpretation. (footnote 9) / (footnote 10)

On the Natural Resources Canada (“NRCan”) website, the term “electrolysis of water” (footnote 11) is described as:

a process that splits water (H2O) into hydrogen and oxygen using an electric current. (footnote 12)

The US Department of Energy offers a similar description of the process on its website. It states:

Electrolysis is the process of using electricity to split water into hydrogen and oxygen. This reaction takes place in a unit called an electrolyzer.

Furthermore, the website clearly illustrates that there are no other products produced. (footnote 13)

Therefore, in the electrolysis of water, the reactant is H2O, and the chemical reaction can be written as: 2H2O--> 2H2 + O2. Electrolysis of water is made up of two reactions, oxidation and reduction, and produces two products: hydrogen gas (H2) and oxygen gas (O2).

D. The Chlor-alkali process

The chlor-alkali process is not a defined term in the Act. It does however have a generally accepted industrial/scientific meaning, which was provided to us by NRCan as follows:

The chlor-alkali process is an electrochemical process that involves the electrolysis of a sodium chloride (NaCl) solution, commonly referred to as “brine” (footnote 14) . The chemical reaction can be written as: 2NaCl + 2H2O --> 2NaOH + Cl2 + H2..

Both Sodium chloride (NaCl) and water (H2O) are reactants in the chlor-alkali process and the chlor-alkali process produces three products:

• Chlorine (Cl2)
• Sodium hydroxide (NaOH) (“caustic soda”)
• Hydrogen (H2).

Unlike the electrolysis of water, the anode serves to produce chlorine and not oxygen.

Hydrogen is generally considered to be a by-product of the chlor-alkali process as opposed to a main product, since it only produces approximately 1% hydrogen by mass.

This process has typically been used in industry to produce chlorine and caustic soda for sale.

E. The Chlorate process

The chlorate process is not a defined term in the Act. It does however have a generally accepted industrial/scientific meaning, which was provided to us by NRCan as follows:

The chlorate process is an electrochemical process that involves the electrolysis of a sodium chloride (NaCl) solution, commonly referred to as “brine”. Both Sodium chloride (NaCl) and water (H2O) are reactants in chlorate process. The chlorate chemical reaction can be written as: NaCl + 3H2O --> NaClO3 + 3H2.

The chlorate process produces chlorate compounds, with sodium chlorate (NaClO3) being the most significant product (i.e., approximately 95% of the production, based on mass). Hydrogen is generally considered to be a by-product of this process as opposed to a main product, since it only produces approximately 5% hydrogen by mass.

Unlike the electrolysis of water, the anode serves to produce chlorine and not oxygen. The chlorine produced in the process undergoes further reaction to form chlorate.

This process has typically been used in industry to produce sodium chlorate for sale.

F. Conclusion

The chlorate and the chlor-alkali processes have different industrial/scientific meanings from the process of the electrolysis of water, based on the foregoing descriptions, which consider the chemical reactant, the chemical reaction and the resulting industrial products. After undertaking a unified textual, contextual and purposive analysis of the term “electrolysis of water” as it is used in the CH ITC legislation, we concluded that it should be interpreted using its generally accepted industrial/scientific meaning. Consequently, “electrolysis of water” would not include the chlor-alkali and chlorate processes with the result that these processes are not eligible pathways for purposes of the CH ITC.

We trust that these comments will be of assistance.

Yours truly,

Kimberley Wharram
Manager, Resources Section
for Division Director
Reorganizations Division
Income Tax Rulings Directorate

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 R.S.C. 1985, c. 1 (5th suppl.), as amended.

2 Archived - Tax Measures : Supplementary Information | Budget 2023

3 Qualifying taxpayer is defined in subsection 127.48(1) as a taxable Canadian corporation, which is a defined term in subsection 89(1).

4 The CH ITC is claimed by a qualifying taxpayer pursuant to the main charging provision in subsection 127.48(2). For information on how to claim the CH ITC, go to Claiming the credit - Clean Hydrogen Investment Tax Credit (ITC) - Canada.ca.

5 See Proposed Amendment to the Act -- s. 1(4) of August 12, 2024 --Legislative Proposals (Budget 2024 and Other Proposals – Clean Hydrogen Investment Tax Credit). It states:

Subparagraphs (c)(i) and (ii) of the definition eligible clean hydrogen property in subsection 127.48(1) are replaced by the following:

(c)(i) that is used to produce all or substantially all hydrogen through electrolysis of water, including electrolysers, rectifiers, purification equipment, water treatment and conditioning equipment and equipment used for hydrogen compression and storage, […]

The accompanying explanatory notes to the draft legislation state:

Subparagraphs (c)(i) and (ii) are amended to clarify that the property described in these two subparagraphs must be used to produce all or substantially all hydrogen. For example, certain equipment would be ineligible if it is used to produce oxygen that contributes to a substantial portion (e.g., more than 10%) of the project's total revenues.

6 The 2024 Fall Economic Statement proposed that the CH ITC be expanded to include methane pyrolysis as an eligible pathway to produce hydrogen and stated that, going forward, the government will continue to review eligibility for other low-carbon hydrogen production pathways.

7 EN May 2024 [S.C. 2024, c. 17 (Bill C-69)].

8 Sullivan, Ruth, Essentials of Canadian Law: Statutory Interpretation (Third Ed.), Irwin Law Inc. (2016), page 74.

9 Ibid.

10 See for example, paragraphs 44 to 48 of Wabush Mines v. Newfoundland (Minister of Finance), 1996 CanLII 11097 (NL CA).

11 Sometimes also referred to as water electrolysis.

12 Canadian Hydrogen Codes and Standards Roadmap - Natural Resources Canada and Producing hydrogen in Canada - Natural Resources Canada

13 Hydrogen Production: Electrolysis | Department of Energy

14 Note: Sodium Chloride (NaCl) is approximately 23% to 28% of the brine mixture, by weight.