Understanding the opportunity of the new direct transfer system
The passage of the Inflation Reduction Act (IRA) has created a momentous opportunity for companies to advance clean energy commitments while lightening tax burdens. Signed into law on August 16, the IRA is the largest climate investment legislation in history, allocating $369 billion to clean energy programs over the next 10 years—including many new clean energy credits and incentives for businesses.
One of the law’s most significant changes is the creation of two new credit monetization methods: direct pay for tax-exempt entities and full transferability of credits for taxable entities. The transferability provision effectively creates a market for buying and selling tax credits. The new credit market means that any company, not just energy producers, can take advantage of clean energy credits. For example, a company installing a solar facility on the roof of its building may be eligible for credits that it can use or sell to another company. All companies should consider how these credits can support their sustainability strategy and lower total tax liability.
Other key credits and incentives changes in the IRA include:
• Extension of existing clean energy tax credits by 10 years, allowing organizations to plan for the long-term.
• Introduction of a base and bonus rate structure for the Investment Tax Credit (ITC) and Production Tax Credit (PTC), where businesses that meet certain apprenticeship and prevailing wage requirements are eligible for a bonus credit up to five times the base amount. Businesses may also be eligible for additional credits, and by taking advantage of these credits, may be able to achieve a bonus ITC as high as 50-60%. Additional credits include:
o 10% domestic content credit.
o 10% energy communities’ credit.
o 10-20% low-income communities’ credit (applies to solar and wind projects under 5MW and only the ITC).
• Allowance for credits to be carried forward up to 22 years and carried back up to three years.
In addition, while the IRA also introduces a new 15% corporate alternative minimum tax (AMT) that will take effect in 2023, the IRA’s clean energy credits are among the AMT offsets that are available to affected taxpayers. Corporations that expect their total tax liability to increase due to the new AMT should consider buying credits to mitigate the impact.
How sellers can monetize credits
Project owners without significant tax liability must decide whether to monetize credits under the new direct transfer rules or use a traditional tax equity structure. Businesses must weigh both options to determine the best path forward for the business and the project.
Direct credit transfers may avoid higher compliance, legal and advisory costs that come with complex tax equity partnership structures but may not allow for the efficient monetization of depreciation. Based on the size and cost of the project, however, there may be an inflection point at which a traditional tax equity structure will yield greater return over a direct transfer. Building a comparative model—either in-house or by working with an advisor—can help a company determine the best structure for its project.
Another consideration concerns the capital structure for new energy projects. When opting for transferring a tax credit, project owners may have to seek additional capital for the initial investment as the credit transaction timing may not occur until the project is nearing commercial operation. To ensure credits can be sold for maximum value, it is critical for sellers of credits to clearly document that the underlying requirements have been met for the credit to achieve the expected value. Companies looking to sell credits should consider working with an independent tax consultant who can certify the underlying requirements, such as prevailing wage and apprenticeship, in a given project have been met to realize the full expected value.
For companies considering a renewable energy project, the time to start construction is now, as projects that are placed in service before year-end, or up to 60 days after the Treasury issues guidance on prevailing wage and apprenticeship requirements, will automatically be eligible for the ITC and PTC at full rates.
While it is still unclear how credits will be valued at the time of sale, the projects that can provide thorough documentation demonstrating credit requirements were achieved will likely transfer at the highest rates.
Considerations for buyers of tax credits
Buyers should perform due diligence on credit sellers’ projects when purchasing credits to confirm the underlying requirements have been met. A buyer who purchases what it believes is a 30% ITC, for example, should be sure that the bonus requirements were satisfied or else risk the purchased credit being worth less than expected. Buyers also need to determine who will take on the risk of recapture or disallowance if the credit does not meet advertised expectations. As the direct transfer market develops, buyers may seek indemnity clauses as part of the credit transfer agreement. Businesses interested in buying credits should consider working with a tax advisor who can help validate credits, ensuring they meet the advertised value.
What’s next for businesses
Treasury is scheduled to issue additional guidance on the prevailing wage and apprenticeship requirements. Here is a calendar of important upcoming dates to watch:
- Event: Projects are eligible for the ITC and PTC at full rates
- Date: Projects placed in service in 2022 and projects that begin construction prior to 60 days after Treasury issues guidance on prevailing wage and apprenticeship requirements
- Event: Projects are subject to a base and bonus credit structure and must meet prevailing wage and apprenticeship requirements
- Date: Projects that begin construction 60 days after Treasury issues guidance on prevailing wage and apprenticeship requirements
- Event: Direct Pay and Transferability go into effect
- Date: January 1, 2023
- Event: Bonus credits and new credits go into effect
- Date: January 1, 2023
- Event: Credits sunset
- Date: Earlier of 2032 or the date that U.S. greenhouse gas emissions are reduced 75% from 2022 levels
Written by Michael Stavish. Copyright © 2022 BDO USA, LLP. All rights reserved. www.bdo.com