The renewable energy industry is eagerly awaiting guidance from the Internal Revenue Service (IRS) to provide guidance on the wide set of rules and regulations that surround the $369 billion in incentives contained within the Inflation Reduction Act.
One provision awaiting clarity to proceed is transferability, or the sale of tax credits. However, the market is moving ahead with tax credit sales without guidance.
This activity was reviewed in a whitepaper written by Keith Martin, co-head of projects, Norton Rose Fullbright. Martin said that production and investment tax credits on solar and wind projects are generally trading between 90¢ and 92¢ per dollar of tax credit. He said that a significant number of these transactions are in the term sheet stage, with some moving into documentation.
“The market is looking to Treasury for guidance about a number of issues, but in many cases, the tax bar has already formed a view and the lack of guidance should not stop transactions from moving forward,” said Martin.
Martin expects prices to rise as more buyers enter the market, especially as deadlines approach to file tax returns and buyers will have a clearer picture of their tax liabilities. He said industry members expect prices settle at 95¢ or 96¢, although some brokers expect them to reach as high as 98¢. Some recent offers in the 80¢ range have been rejected by sponsors, said Martin.
The Inflation Reduction Act enables clean infrastructure owners to sell nine different types of tax credits to others for cash. Credits generated after 2023 are eligible, and the rules of these sales can be found in section 6418 of U.S. tax code. There are nine types of tax credits that can be sold. U.S. tax code 45, 45Y, 48, 48E, 45Q, 45V, 45U, 45Z 45X, 48C and 30C set the rules for these credits.
The nine credits are production tax credits for generating renewable or nuclear electricity, capturing carbon emissions or producing clean hydrogen and clean transportation fuels (like sustainable aviation fuel), tax credits for manufacturing wind, solar and storage components or processing, refining or recycling 50 types of critical minerals.
The tax credits also apply to building new factories and re-equipping existing assembly lines to make or recycle products for the green economy and reduce greenhouse gas emissions at existing factories by at least 20%. There are tax credits for installing electric vehicle and other clean fuel charging stations in low-income and rural areas.
Tax credits can only be sold once, and a buyer cannot resell the tax credits it purchases. The buyer must pay cash, and tax credits that are carried into one year from another year cannot be sold.
The deadline to sell tax credits after they are generated is at least until year end and likely the due date for filing the tax return for the year, said Martin. For example, 2023 tax credits could be sold up until the seller files its 2023 tax return in 2024. The buyer claims the tax credits in its tax year that ends on the same date as the seller’s tax year, or the date that straddles the back end of the seller’s tax year for buyers with different tax years. The buyer can carry credits forward if not used immediately.
Sellers must notify the IRS of the sale by filing an election. The sales proceeds do not have to be filed as income. Buyers pay less than a dollar per dollar for the credits so they may profit from the transaction.
Tax equity partnerships
Martin said that it is now standard practice in partnership-flip tax equity transactions for the tax equity investor to require the right to direct the partnership to sell credits. All tax equity transactions involving production tax credits, and 80% of tax equity financings involving investment tax credits, are structured as partnership flips, said Martin. Read more Norton Rose Fullbright insights on solar tax equity structures and partnership flip structures and issues.
One might wonder why a project developer would carry transaction costs to put tax equity financing in place and then incur more of such costs to have the equity partnership sell the credits. The tax equity investor demanding the right to force a sale sometimes pays the sale costs, said Martin.
“Combining both approaches allows the developer to ‘step up’ the tax basis on which investment tax credits and accelerated depreciation are calculated by selling the project company to the tax equity partnership near the end of construction for the appraised value the project is expected to have when fully built,” Martin said in the whitepaper. “When the tax credits are later sold, they are calculated on the fair market value rather than the bare cost to construct.”
Rising tax equity also offers the developer value for the depreciation on a project, said Martin. Tax credit sales are also a way for some tax equity investors who lack current tax capacity to remain active in the market.
“Another reason to try to move a project into a tax equity vehicle is tax equity provides upfront funding for projects on which production tax credits will be claimed over 10 years on the electricity output,” wrote Martin. “PTC sales are likely to draw annual or quarterly payments as tax credits are earned. Some banks are exploring lending bridge debt against the future payment streams in cases where there have been forward sales of all 10 years of tax credits. However, early offers from lenders have been at advance rates as low as 50% of the future payment streams.”
Sales of tax credits by equity partnerships raise a few problems, which Martin outlined in the whitepaper. For one, the partnership will have to indemnify the tax credit buyer if the tax credits are recaptured or disallowed by the IRS. Norton Rose Fullbright’s analysis of the four complications can be found here.
Guidance needed
Companies are looking for guidance on whether a partnership between a private developer and such investors qualifies for a cash payment for the share of tax credits that belongs indirectly to the tax-exempt or government entity. The market assumes the answer is no, said Martin.
Another issue to be clarified is whether the tax credit buyer must report income equal to its profit when it uses the tax credit to extinguish a tax liability.
And, the Inflation Reduction Act remains unclear on who gets audited and has to pay any audit adjustment where tax credits have been sold. The market assumes that the IRS will come after the seller for any taxes that have to be paid after a recapture or disallowance of sold tax credits, but the Treasury must confirm this, said Martin.
