The Inflation Reduction Act of 2022 provides for the transferability of certain renewable energy tax credits, including the investment tax credit (ITC). As preliminary additional guidance was just recently released by the Internal Revenue Service (IRS), below are various transferability insights both developers and investors should keep in mind as they consider credit transfer transactions, including in respect of pricing, transaction costs and timing (and how those compare to more traditional renewable energy financing structures), federal income tax consequences to buyers and sellers of the credits, recapture and more.
Investing in renewable energy tax credits is going to be a key initiative for corporations in the future as they help to achieve the dual objectives of pursuing transactions with a sustainability aspect while at the same time providing tax credits to reduce tax liabilities of corporate investors. We would expect that as the market becomes more mature (following the release of the recent IRS guidance and the finalization of such guidance in the coming months), interest in transferable credits will exponentially increase as more and more investors begin to consider these types of transactions. Overall though, we believe that this will be a buyer-friendly market as relates to pricing and deal protection terms.
- The earlier one transacts, the greater the benefits to early buyers, as prices should be discounted further before the market fully develops.
- Transferability has simplified the structure of renewable energy tax credit investment transactions (i.e., no longer required to invest through complex partnership or lease structures), resulting in a substantial decrease in the cost of advisors – although traditional renewable energy financing structures will still play a role for some interested parties (e.g., monetization of depreciation as one example).
- The buyer is required to pay for the transferred tax credits solely in cash, which payment is not deductible by the buyer, and to report the tax credit transfer on its timely filed tax return (including valid extensions) for the year in which the credit arises.
- The seller is required to report the tax credit transfer on its timely filed tax return (including valid extensions) for the year in which the credit arises, and the cash payment received by the seller from the buyer in exchange for transferred tax credits is not taxable income to the seller.
- Unlike traditional renewable energy financing structures (which require investors to be in the partnership before the asset is placed in service and have 20% of equity invested prior to mechanical completion), a key benefit of transferability is that it provides a longer runway for sellers to identify buyers (i.e., the deadline to sell the credits is the earlier of the seller’s due date or the buyer’s due date for timely filing (including valid extensions) their respective original tax returns that would include the credit).
- Recapture rules require that the renewable energy property stays in service for a certain number of years, or else all or a portion of the credit may be recaptured; although the buyer will be responsible for any amount subject to recapture, the seller will be responsible for notifying the buyer when a recapture event has occurred; however, the risk of recapture will ultimately shift back to sellers as buyers require indemnity agreements to be negotiated.
- Tax credit insurance may offer an additional source of comfort for investors unwilling to rely solely on the creditworthiness of the sellers.
We will be watching the IRS guidance closely to see the extent to which these (and other open issues) are hopefully clarified/resolved in the near term.