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To Market, To Market: Tax Credit Transfers Start Rolling Along
Reprinted with permission from Tax Notes - Volume 181 | October 30, 2023
The Inflation Reduction Act opened the market for buying and selling energy tax credits by creating a new asset class. One result of that innovation was the launch of new marketplaces in which buyers and sellers can transact. A novelty in the federal tax area, tax credit marketplaces are working to establish themselves as a key aspect of the implementation of both the new and the dramatically revised energy credits.
The objective of the marketplaces is to facilitate credit transfer transactions by bringing buyers and sellers together and helping them complete their deals efficiently. The early deals appear to be mostly dominated by established participants in the traditional tax equity market, but the founders of the new marketplaces see a chance to both assist in those transactions and turn the untapped potential of smaller projects and new credit purchasers into completed deals.
New market, new marketplaces
As the recent spate of announcements has heralded, the market for credit transfers is taking off. “There are very few tax planning strategies that can have as large an impact as this can have for a single transaction, but it’s all based on scale,” Gabe Rubio of BDO USA LLP said. Where marketplaces fit within the credit transfer market is still being determined, but there are indications that they’ll play an important role.
“There has been an awesome amount of demand from clean energy project developers,” said Andy Moon of Reunion, an energy tax credit marketplace that launched this year. His company currently has $3 billion in credits from hundreds of developers on its platform from leading solar, wind, and other project developers. Moon said that because of the shortage of available tax equity and the complexity involved in tax equity partnership structures, there is a growing realization that transfers will be an important part of the financing toolkit for all developers.
One of the challenges is that the population of sellers is reasonably well defined, but the population of potential buyers is not. “People are interested and are feeling out the market but are trying to figure out how the process works and figuring out what they need in order to be able to transact,” said Seth Feuerstein of Atheva, another credit marketplace. For the sellers’ part, they’re often learning what buyers want, he said. That learning process will continue as the market matures.
By educating buyers and sellers and making transactions significantly less onerous than tax equity deals, the marketplaces hope to help the market mature faster. Moon said Reunion is focused on educating market participants and ensuring that transactions are done properly and are good experiences for buyers and sellers. “Part of why we’re interested in providing our knowledge to the market, including to our competitors, is that if there is fraud or recapture, that’s bad for us too,” he said.
The transactions facilitated by the marketplaces still involve outside counsel for each party to the deal. Moon said that Reunion helps lower expenses for buyers and sellers by guiding the due diligence process and providing a starting point with standardized documents that the parties and their counsel can customize through negotiations. There are additional benefits to having a nonparty facilitator whose role is to efficiently move the transaction to closing, he noted. For example, he explained that while developers may seek higher-than-market sales prices initially, Reunion has been able to bring its market expertise to the table to help buyers and sellers achieve a price that makes sense. “The go-between role is important,” he said.
Moon said that the long-term vision for Reunion’s role in the market is to be a place where many buyers and sellers can transact regularly in an auction style and to offer buyers the ability to purchase a portfolio of many projects. “Right now, buyers want projects with scale, but by the time we get to the later part of 2024, one thing that we anticipate is more, smaller projects with larger discounts,” he said. The key to those deals will be risk mitigation.
The marketplaces might also carve out a niche as matchmakers between buyers and sellers who don’t already know each other by helping them to find the right deal partners. Rubio said that the marketplaces could provide a valuable service to clients that have very specific parameters.
Transfers on the rise
Both on and off of the marketplaces’ platforms, credit transfers have taken off. Rubio said his firm closed transfer agreements of just under $300 million in credits in September. “VPs of tax are starting to wake up to this, as are developers, and it is becoming a very relevant tax and cash planning strategy,” he said. That growing awareness is why the credit transfer market is on an upward trajectory.
Moon predicted that the rest of 2023 and early 2024 will continue to see bilateral transactions, as the process becomes more familiar to purchasers. “Once a company and their finance team get comfortable with the process, there’s no reason not to continue to transact at equal or larger volumes in future years,” he said.
The market is currently heavy on solar projects, probably because that technology is among the most prevalent and there are many small solar projects that drive up the numbers, said Feuerstein. He added that developers have shown a preference for selling investment tax credits because they generate more income for the seller, but production tax credits are actually easier to sell because of the lack of recapture risk. So far, there doesn’t appear to be much of a difference in sales price between ITCs and production tax credits.
Risk mitigation is one of the major focuses of the credit marketplaces. Treasury and the IRS stated in the proposed regulations that the risk of recapture should be on the buyer, with a few exceptions in the case of partnerships and S corporations, but they allowed transferors to indemnify transferees. The focus in deals is now on mitigating the recapture risk through insurance and guarantees that let buyers feel more secure about their purchases. “All of our agreements put the burden of recapture on the seller,” Feuerstein said.
The IRS says it expects to open a registration portal for credit transfers by the end of the year, the main missing link in the transfer process. Credits sold today still have to be registered. Uncertainty about what exactly that prerequisite will entail is causing some additional friction in the market, but it’s “more of a hurdle than a barrier,” Feuerstein said.
The price range for credits is still fairly wide, but it’s starting to crystallize, and it will probably narrow over time. “The highest we’ve seen is 94 cents [on the dollar],” Feuerstein said. But sales in the low-80-cents range are also happening, and some sellers may even go into the 70s. “The pricing depends on the size of the credit and the creditworthiness and reputation of the seller, among other things,” he said.
Moon said that for the 2023 tax year, current production tax credits sell in the mid-90s, and ITCs from established solar, wind, and battery storage developers are in the low 90s. Technologies that now have a smaller pool of buyers, such as biogas, are trading around 90 cents or in the high 80s, he said. “Smaller projects, projects from newer developers, or projects with more risk or complexity may have a discount in the mid-80s,” Moon said. Looking forward to 2024, the options will increase with additional technologies, such as carbon capture, and new structures. For example, buyers could lock in a larger discount by committing to purchase tax credits for projects that will be placed into service at least 12 months in the future.
The proposed regulations established that the discount at which credits sell isn’t taxable income to purchasers, which has caused sales prices to rise. Moon noted that from the standpoint of the internal rate of return, the returns on purchases are quite healthy because the credits can be used to offset quarterly estimated payments.
The successful completion of the initial credit sales is likely to serve as a proving ground for the process. Buyers and sellers of smaller credits in particular may be the beneficiaries of the collective knowledge and eventually more standardized processes that follow on the heels of the initial transactions. “It’s harder to justify the transactional expense necessary for a smaller transaction,” Rubio said. He said that he hasn’t seen a completed sale of a credit under $5 million so far, but that is likely to change as the market develops.