The “Big, Beautiful Bill” and the implications for corporate taxpayers and the clean energy industry

On June 14th, the US Treasury released guidance on the tax credit transferability mechanisms established by last year’s Inflation Reduction Act. This highly anticipated announcement provides proposed regulations for credit transfers under Section 6418. In this article, we will share initial insights and takeaways from the guidelines, and share thoughts on their effect on clean energy  financing moving forward.

The overall industry reception to this week’s guidance appears positive, as it has largely followed expectations that market participants were anticipating. The guidance provided three key things to enable more investment into renewable energy projects:

• Certainty that corporate taxpayers can utilize the credits as intended, as well as clear guidelines that will allow transactions to move forward.
• A clear delineation of the risks and who will be responsible for them. 
• A relatively low-burden process for registering, transferring, and claiming the credits.

Takeaways from Treasury guidance were largely positive 

1. Clarity on transfer mechanics

Sellers electronically pre-register with the IRS, receiving a project identification number associated with each tax credit eligible property. Sellers and buyers must file a transfer election statement, which includes the registration number and is attached to the seller's and buyer's tax returns.

The transferee and transferor may file their returns in any order, as long as the transferee return is for the taxable year in which the eligible credit is taken into account under the rules of section 6418.

The IRS has released an FAQ with more details on the transfer process.

2. Narrows risk to buyer on tax credit recapture 

As expected, recapture risk sit with the buyer; however, the risk to the buyer is narrowed through the following clauses:

• The Proposed Credit Transfer Rules expressly permit indemnification relating to recapture of the buyer by the seller
• A change in upstream ownership of a partnership or S corp does not cause recapture for the buyer of the credit, although this would trigger recapture to the shareholder or partner who sold their interests.

This is one of the most positive outcomes of the proposed regulations. Developers are often structured as partnerships, some with many different equity owners. Subjecting tax credit buyers to the risk of upstream changes of control that inadvertently cause recapture is a difficult risk to manage, and would likely not be covered by tax credit insurance. Additionally, sponsors may opt to continue using some form of backleverage (where a partner in the partnership that owns a project is the borrower, as opposed to the partnership itself), instead of negotiating forbearance agreements from lenders.

Unfortunately this does not change the risk profile to a developer, and they will still need to think carefully about structuring deals to avoid recapture.

3. Proceeds to buyer are tax-exempt

Another large positive for prospective buyers is that income made from a purchase of a tax credit is non-taxable. If a buyer pays $45M in cash for a $50M credit, they would not be taxed on the $5M proceeds. This is also beneficial for sellers, as it should create a market equilibrium that is closer to the true cost of the credit, and help them extract more value from their sales.

4. Supports activities of partnerships and intermediaries

The guidance confirms that partnerships or S corps may qualify as eligible taxpayers or transferee taxpayers. This opens up additional transaction structures, and seems to enable syndication mechanisms similar to those in existing tax equity transactions. 

Guidance also confirmed that intermediaries can support transactions without violating the rule against second transfers, which is helpful clarification that should allow third party financial institutions and platforms, such as Reunion, to assist with facilitating transactions.

5. Credits can be purchased in advance

As expected, advanced purchases of eligible credits are permitted, as long as the cash payments are made within the specified period. In an industry that deals with a long timeframe and complex, large-scale projects, this is a welcome clarification that should narrow the timing gap, and allow sellers additional opportunity to find short-term financing from lenders and investors.

6. Credits can be factored into estimated taxes

In accordance with advanced purchases, buyers will be able to think ahead by tax planning credit acquisitions. “A transferee taxpayer may also take into account a specified credit portion that it has purchased, or intends to purchase, when calculating its estimated tax payments, though the transferee taxpayer remains liable for any additions to tax in accordance with sections 6654 and 6655 to the extent the transferee taxpayer has an underpayment of estimated tax.”

This is particularly meaningful, as a tax credit purchaser can calculate estimated tax payments in anticipation of future purchases of tax credits. From a time value of money standpoint, this accretes value to the purchaser in the context of forward purchases of tax credits.‍

7. Flexibility on 20% excess transfer fee

There is a 20% fee for excess credit transfer, but this “does not apply if the transferee taxpayer demonstrates to the satisfaction of the Secretary that the excessive credit transfer resulted from reasonable cause.” The guidance provided specific examples of what constitutes reasonable cause, and generally reflects standard due diligence efforts that Reunion would facilitate with respect to transactions on our platform.

8. Timeline for opening of registration portal 

Lastly, the guidance confirms that the portal for registering and filing elections should open in late 2023. This should not be limiting, as most market participants expect that deals agreed upon in pre-registration will be able to be filed normally once registration opens later this year. The formal filings on the portal will provide for greater market transparency, and ensure that the same credits are not transacted twice. 

Several takeaways from Treasury guidance were less positive 

9. Lessees in lease pass through transactions are not allowed to transfer credits

This is one of the biggest surprises of the guidance, as most market participants had been expecting that such transfer would be allowed, and a number of transactions have closed based on this assumption. Given that a lessor is explicitly allowed to pass through an ITC at FMV (as opposed to cost), this could be the first indication that the IRS will be heavily scrutinizing transactions that step up basis.

In general, basis step up is a topic that is controversial, important, complicated and subject to interpretation. Most importantly, challenges to qualified basis are the most likely meaningful risk that a tax credit transferee assumes. We will be doing a deeper dive in this area in the near future; stay tuned.

10. Base and bonus credits must be sold in vertical slices

A seller has flexibility on the amount of credits they would like to sell, and can sell credits from one facility to multiple buyers. However, base and bonus credits cannot be sold separately; each buyer must receive a “vertical” tranche that includes a pro rata portion of base and bonus credits. 

Said differently, all tax credit purchasers buying tax credits from a particular project are buying the same credit; if there is a reduction of credit, all purchasers will suffer a pro rata reduction. Sponsors were hoping to be able to sell different tranches of credits, at different pricing and risk profiles. While it is possible to synthetically allocate risk amongst a set of credit purchasers through contractual means, it remains unclear whether this will emerge as a common practice. 

11. Passive loss rules continue to apply

While the guidance proposes that active/passive rules are expected to apply, they are requesting further comments. For the time being, we believe that it will remain challenging for individuals to participate in tax credit sales, other than to offset passive income.  

Conclusion

Treasury Guidance was widely applauded by the clean energy industry for providing clarity on how project developers and investors can take advantage of transferable tax credits, a key financing tool of the Inflation Reduction Act. One goal of the IRA is to attract wider participation in clean energy financing through tax credits; Treasury guidance has provided the clarity that corporate investors will need to move forward with clean energy tax credit purchases. According to Treasury Secretary Janet Yellen, “More clean energy projects will be built quickly and affordably, and more communities will benefit from the growth of the clean energy economy."

Reunion is excited to play a part in accelerating the clean energy transaction. To learn more, please reach out to us at info@reunioninfra.com. 

There is a “missing middle” in the market for renewable energy that won’t be missing for much longer.

The U.S. Treasury Department on Wednesday announced new guidance, authorized under the Inflation Reduction Act, that will enable the development of a range of renewable energy projects that previously had been too onerous from a tax perspective to tackle.

It also allows cities and nonprofits, which have no tax liabilities, to receive direct payments when investing in a range of climate-friendly technologies. The changes could pave the way for hundreds of billions of dollars worth of investment in the coming decade.

The guidance around direct payments would allow tax-exempt organizations to put rooftop solar panels on schools, churches and temples. Electric school buses, already an attractive purchase for many districts, will be that much more attainable. And rural electric cooperatives will finally be on the same footing as investor-owned utilities.

But perhaps the bigger news is the guidance around transferability of tax credits. Previously, to make the most of the tax credits available to them, renewable energy project developers had to create complex and expensive tax equity deals.

A solar project, for example, might be eligible for 30% to 50% of its total cost in tax credits. Utility scale projects routinely cost $100 million to $200 million, meaning that up to $50 million to $100 million in tax credits would be available.

“The numbers get very large, very quickly in infrastructure,” said Andy Moon, co-founder and CEO of Reunion, a renewable energy tax credit marketplace. “As a result, most companies just don’t have the tax liability to absorb those credits.”

The organizations that do are almost always banks, which have the expertise and tax liabilities to handle tax equity deals. Very large banks tend to dominate. Together, JP Morgan and Bank of America have accounted for up to half the market for tax equity. Since there’s a limit on the number of banks willing to enter into such deals (and a limit to their tax liability), only about $20 billion worth of tax equity deals are done every year.

With transferability, though, there might be as much as $90 billion worth of renewable energy tax credits available by the end of the decade, according to CohnReznick Capital, far exceeding the amount that today’s tax equity deals can absorb. Transferability opens the market to a much wider range of companies with lower tax liabilities.

The market is in its earliest days, but already companies like Reunion are popping up to handle such transactions. The startup is standardizing the process to transfer tax credits, streamlining everything from legal documents to due diligence and insurance. As it handles more projects, it plans to start digitizing more parts of the process. “The idea is to really automate it and make it such that we’re democratizing both the funding side as well as the project side,” Moon said.

Moon and his co-founder Billy Lee started the company shortly after the Inflation Reduction Act was passed. The two had worked for years in renewable energy finance and recognized that transferability was poised to create an entirely new market. They raised a $2.9 million seed round led by Segue Sustainable Infrastructure, TechCrunch+ has exclusively learned, and they’ve spent the last several months lining up customers.

Moon said his company is focused on companies with $500 million in revenue and greater, but the plan is to open up to smaller businesses and projects as Reunion gains experience and automates more of the process. A startup with $1 million in annual profit could, for example, buy six figures worth of credits, which would enable smaller projects to offload their tax credits.

Buyers of tax credits typically receive a 7% to 10% discount, which compares favorably with the usual returns for tax equity, which are around 8%, Moon said. This year, Reunion has about $300 million worth of credits for sale on its marketplace.

By allowing the transfer of smaller amounts of tax credits, transferability promises to enable a range of renewable energy projects. One example might be a single warehouse that wants to install solar with batteries and would like to own and monetize the installation. Before transferability, tax liabilities weren’t nearly high enough to make such projects worthwhile. But with transferability, the upfront capital costs become more manageable and the payback period shortens dramatically.

While solar is likely to represent a large portion of the transferred tax credits, a range of other climate technologies are eligible, including wind, geothermal, tidal, energy storage (like batteries), fuel cells and more. That should help create markets for a range of technologies that might have been too small to be profitable under the old tax equity regime.

That tidal microturbine startup you’ve been incubating? Now might be a great time to start looking for investors.

Corporates are now one of the most prolific forces on the planet for meaningful climate action. Who saw that coming 10 years ago!? A leading benchmark group, Science Based Targets initiative (SBTi), now counts nearly 5,000 companies taking action, with 2,600+ companies setting formal science-based targets and 1,800 companies with net zero goals. 

A key decarbonization activity has been to offset electricity-related emissions (also known as “Scope 2” emissions) by purchasing electricity from renewable energy generation–often via a corporate power purchase agreement, or PPA. 

While PPAs have been a great tool to drive new renewables build-out, not every corporate has the financial strength, risk appetite, or ability to sign up for long-term PPA contracts, which typically run for 10 to 20 years. Fortunately, following the passage of the Inflation Reduction Act (IRA), sustainability leaders now have even more ways to tackle their Scope 2 emissions targets. 

Tax credits – why do they matter? 

A central feature of the IRA was the expanded tax credit regime. Now, renewable energy and sustainable infrastructure projects can qualify for 10+ years of tax credits which can be monetized as part of the project financing process. 

These tax credits have drawn a lot of attention for driving top line growth projections for renewables. For example, Wood Mackenzie estimates that solar, wind, and battery storage alone could produce as much as $90B of tax credits per year:

As the chart below shows, the IRA tax credit incentives will help drive significant deployment of new wind, solar and other sustainable technologies. .

Less attention has been paid to where this capital comes from. Because the vast majority of clean energy funding in the IRA came in the form of tax credits, the unspoken assumption is that corporate taxpayers will simply monetize these credits for project developers as they did with pre-IRA tax credits. But going from a tax credit market that was traditionally in the $18B-$20B range pre-IRA to one that is 2-3x larger or more post-IRA will necessitate a large number of new corporate taxpayers to enter the market and trade tax capacity in the form of cash for tax credits. 

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What does this have to do with corporate sustainability? 

As corporates look for energy-related sustainability tools beyond the PPA, investing capital directly into projects via tax equity or its new post-IRA cousin, transferability, is an appealing option.  Some companies like Starbucks, Facebook, and Nestlé, have invested in tax credits with great effect already. 

With the IRA’s new transferability provision, the process is more straightforward than tax equity; companies with tax liability (which they have to pay anyway), can instead purchase tax credits at a discount. For example, paying $0.90 for $1.00 of tax credits on $50M of tax liability would net an immediate $5M savings.

Investing in transferable tax credits has a sustainability story, and it drives meaningful clean energy impact. But there’s a catch–the investment activity of monetizing tax credits on behalf of a specific renewable energy project doesn’t “count” towards Scope 2 emissions reduction targets. The corporate, despite putting tens or hundreds of millions of dollars into a project, would also need to buy the energy attribute certificates (EACs) or renewable energy certificates (RECs) to make a formal “green” claim. 

Fortunately for sustainability leaders, the savings generated by purchasing tax credits–$5M in our example above–could be redirected to offset the cost of REC procurement. This approach helps bring sustainability activity more directly into alignment with the financial incentives of the business.

“From a CFO’s perspective, an interesting feature of the green-energy credits is a provision in the law that makes the credits transferable one time”

Deloitte, “For CFOs, the full impact of the Inflation Reduction Act is still coming into focus”

Corporate sustainability leaders can be internal champions for tax credit purchases

Corporate sustainability leaders should champion tax credit purchases inside their company for three reasons:

1. It drives real impact – as noted above, tax credit monetization is a real, measurable, and impactful way to put steel-in-the-ground. Without tax credit financing, projects don’t get built. Any company putting $20M, $50M or $100M+ of tax capacity to work financing projects is directly accelerating the energy transition.
2. It fills an enormous funding gap for clean energy – also noted above is the gap between today’s tax credit investment  market (~$20B annually) and the very near future of ~$60 to $90B  in annual demand for tax credits. . Only taxpaying corporates can effectively monetize these credits to enable projects. Without them, the promises of the IRA and much of the decarbonization effort falls short. 
3. It provides an economic benefit for action on sustainability – unlike RECs and PPAs which are often a net cost to the corporation, tax credits are a net benefit, saving 7-10% annually on tax liabilities that the company is already responsible for. These savings can be reinvested in REC purchases or other activities to secure the desired environmental attributes. 

Conclusion – sustainability teams can “do well and do good” with tax credits

Given the deep necessity of more corporates putting their tax liability to work in monetizing tax credits for renewable energy project developers, sustainability teams are a natural place to start for leading this effort. 

The alignment of doing well, by improving the bottom line via tax savings, and doing good, by sending already spoken for capital directly into renewable energy projects, should have any sustainability leader excited to pick up the phone and call their corporate finance team to get started.

Anyone who has developed solar projects knows about the “December rush” – all hands on deck to get projects built and interconnected, hounding utilities for inspections and PTO letters, coordinating last minute signature pages up until COB on New Year’s Eve – all because tax equity investors generally allocate tax capacity on an annual, tax year basis. If tax equity commits to fund a project in a certain year, it wants to make sure it gets the expected tax benefits from that project in that tax year. Accordingly, there is significant pressure for developers not to miss the 12/31 deadline, and often there are significant financial penalties if they do – hence, the December rush that many developers and financiers know well. (For years, my peers and I never took vacation until January 1st.)

Transferability is appropriately labeled a “game changer.” Having worked in project finance and tax equity for nearly 20 years, I knew that the ability for clean energy tax credits to be freely bought and sold would be transformative and disruptive. So much so, that soon after the passage of the Inflation Reduction Act, I dropped everything and launched Reunion with my longtime colleague and renewable energy veteran, Andy Moon.

Lately, I’ve heard some people mention that transferability gives developers the “gift of time” and will alleviate the massive pressure to place projects in service by the end of year. Unfortunately, transferability, while transformative, is not a panacea for all challenges.

What is the gift of time?

In a typical tax equity partnership transaction, a tax equity partner must fund 20% of its investment by mechanical completion. Time is not a developer’s friend; as a project approaches COD, the need to close tax equity becomes more and more urgent (and a developer’s leverage in tax equity negotiations diminishes). With the IRA, this urgency becomes less pronounced, because the developer always has a fall back option to sell tax credits.

With transferable tax credits, Section 6418 of the Internal Revenue Code (IRC) indicates that the seller of the credit has until the filing date of its tax returns (as extended) to sell the credits.  Therefore, the owner of a project that is being placed in service on 12/31/2023 can sell the associated 2023 tax credits up until 9/15/2024 (the extended filing date for partnerships). If the project is placed in service on 1/1/24, it generates a 2024 credit but that credit can be sold up until 9/15/2025.

This certainly gives developers more flexibility on when to sell the credit. However, what hasn’t changed is that tax credits (specifically, the IRC §48 investment tax credit which applies to solar, storage and other technologies) are generated when the project is placed in service. So a project placed in service on 12/31/2023 will generate a 2023 tax credit, whereas a project placed in service on 1/1/2024 will generate a 2024 credit. This is true whether or not the tax credit is transferred or allocated to a partner in a traditional tax equity partnership. 

So a tax credit buyer who has agreed to buy a 2023 credit from a project developer to reduce its 2023 tax liability will not be obligated to close the purchase if the project slips to 2024 (unless of course, this has been contemplated in the deal documents and priced accordingly).

The IRA does include a three-year carryback provision, but it’s not straightforward to utilize

At first blush, the three-year carryback seems like an incredible tool to unlock significant tax liability and add flexibility. However, actually utilizing the carryback is cumbersome in practice; it is not as simple as just carrying the credit back to the prior year.

In the example above, a developer misses the year end deadline and places a project in service on 1/1/2024. It sells the 2024 credits to a buyer who wishes to apply those credits against 2023 liability. Unfortunately, the buyer must first apply those credits against its 2024 liability. Only to the extent that there are unused credits after application against 2024 liability can the buyer carryback the credits. But it must first carryback the credits to the earliest possible date applicable, or 2021; any unused credits would then be applied to 2022; then finally to 2023. Buyers do not have the discretion to pick and choose which years to apply carryback credits.¹

Practically speaking, carrying back credits would require a buyer to amend one or more of its prior year returns, which has its own complexities (Joint Committee review, increased audit risk, etc.). The juice may not be worth the squeeze.²

Reunion is committed to sharing transparently both the benefits and risks of transferable tax credits, based on our years of experience structuring renewable energy finance transactions. Transferability will unlock billions of dollars in additional renewable energy financing, by attracting new investors to the space with a simplified and low-risk investment process. However, tax credit buyers will continue to need to ensure that the developers they work with are able to deliver tax credits within the desired tax year. Reunion can help both tax credit buyers and sellers navigate this challenge.

If you'd like to learn more about how Reunion can help you buy or sell the highest quality clean energy tax credits, please reach out to info@reunioninfra.com.

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Footnotes:

[1] IRC §39 is the code section that governs carrybacks.

[2] Anecdotally, many people don’t realize that the pre-IRA §48 credit had a one-year carryback feature, and not surprisingly, was rarely employed in prior tax equity deals.

The Inflation Reduction Act last August let companies sell nine types of federal tax credits to other companies for cash. The window opened on such sales on January 1. Five market veterans discuss how the market is developing. Moderator Keith Martin is joined by Ted Brandt, CEO of Marathon Capital, Jack Cargas, Managing Director and Head of Tax Equity Origination at Bank of America, Billy Lee, President of Reunion (an electronic trading platform), Rubiao Song, Managing Director and Head of Energy Investments at JPMorgan, and Jamie Stahle, Senior Managing Director of CCA Group.

The Inflation Reduction Act of 2022 (IRA) was a sweeping bill with many implications for the energy transition–particularly the financing of new projects. In the IRA, Congress specifically sought to incentivize private sector investment into the energy transition. One of the most prominent ways they did this was through tax credits, to incentivize corporate taxpayers to redirect capital into the clean energy and sustainable technology industry.

A recent assessment of the IRA from Boston Consulting Group (BCG) and Breakthrough Energy puts a fine point on the value of tax credits in switching to low carbon energy, by demonstrating the impact of tax credits on levelized cost of energy (LCOE).

Per BCG’s analysis, tax credits from the IRA and other major energy-related legislation can drive between 20% and 60% reductions in LCOE across six technology types. But a low LCOE and actual steel-in-the-ground are not the same thing. To physically deploy these less expensive technologies, project developers will require many billions of dollars of project finance capital.

Bloomberg illustrates just how significant the demand for investment dollars may be over the next 25-30 years. This demand is a powerful function of government policies, decarbonization goals of Fortune 500 companies that increasingly extend down into global supply chains, and the aforementioned plummeting LCOE that allows low carbon energy technologies to displace incumbent coal, gas and oil-based power generation. That’s a very difficult demand-pull force to derail once it gets going.

The opportunity and challenge of tax credits for project finance

So where will all this capital come from? In the U.S. the IRA’s tax credit regime significantly enhances project capital stacks with upwards of $500 billion of tax credits over the next 10-20 years, depending on various estimates and factors. Here’s one such estimate from Credit Suisse, which projects $576B in tax credits over a 10-year period.

The IRA also enhanced the value of tax credits on a project-by-project basis. For example, developers can now monetize up to 70% of a solar project’s costs with the addition of bonus credits. Project developers typically are not able to absorb the tax benefits from their projects, and traditionally would tap into a $15B-20B tax equity market to finance the tax credit portion of any given project. With the enhancements from the IRA, the renewable energy sector could require up to 3.5x market growth by 2030 and possibly ~5x growth by 2049 according to demand projections by Wood Mackenzie. And that doesn’t even include fuels, CCUS, hydrogen, manufacturing or any of the other tax credits created by the IRA. That's a lot of external tax appetite being put to work that did not previously participate in this market.

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Monetizing tax credits for project development will be one of the primary barriers to clean energy deployment, particularly in the initial years following the IRA legislation as corporate tax groups are educated on the opportunity to redirect their tax payments into renewable energy tax credit investments.

Recruiting capital into sustainable technology tax credits with transferability

Following the IRA, the question developers now face is how quickly and to what extent they'll be able to monetize these benefits as they execute on their development pipeline.

Tax credit-related capital has traditionally come from large banks such as JP Morgan Chase, Bank of America, Wells Fargo, and US Bank; a handful of banks account for the majority of tax equity investment capital in recent years.

The IRA legislation seeks to broaden this pool of capital to meet the anticipated demand represented above in the WoodMac chart. To do this, they created a transaction mechanism called Transferability which allows project developers to monetize their credits with a simple purchase-and-sale agreement, rather than the traditional equity partnership investment structure.

Here is a detailed description of transferability.

Transferability as a promising solution

Transferability isn't intended to replace traditional tax equity; instead, it gives corporate tax and treasury teams an alternative pathway to:

• Easily secure tax benefits to offset their federal income tax liability, and
• Participate in financing new, renewable energy and sustainability infrastructure that aligns with their corporate ESG goals

The value proposition for corporate taxpayers is simple: redirect your tax payments into clean energy projects and receive a discount on your federal tax liability. The reality is a little more complicated – tax credit purchases do carry some risks and reporting requirements, so partnering with third parties on transactions can often streamline the process. But earning an estimated 8%-10% discount on federal tax with controllable risks will be an attractive proposition to corporate taxpayers who may have chosen not to pursue traditional tax equity investments. 

If the IRA is successful in its goal to scale more established technologies while kickstarting newer technologies like hydrogen and CCUS, a deep market for transferable tax credits could develop by 2030 with wider pricing spreads and creative structures used to pull more capital in from corporate taxpayers. 

In conclusion, while it’s early days in the post-IRA renewable energy project finance market, the outlook is bright for both sustainable technology growth broadly speaking and for transferable tax credits sales specifically. 

About Reunion

Reunion Infrastructure is leading the market on transferability as a service by packaging market expertise with core services needed to execute rapid, de-risked, and repeatable transferable tax credit transactions. Through its marketplace platform, Reunion provides:

• Access to a best-in-class range of project and tax credit types
• The ability to bundle different project or credit types into risk-adjusted portfolios
• Comprehensive due diligence and legal documentation to project buyers
• Access to tax credit insurance products
• Reporting services to ensure credit transactions are properly recorded 

To learn more about Reunion, please contact Kevin Haley at kevin@reunioninfra.com.