| Work Detail |
David Burton, a Norton Rose Fulbright attorney specializing in energy tax law, discusses tax credit transfers, local content, energy communities, the prevailing wage, and more.
It’s been two years since the passage of the Inflation Reduction Act of 2022 (IRA) , and like any complicated, multifaceted policy, the IRA is a mix of successes and failures. Let’s start with the successes.
The IRA created a market for tax credit transfers, and it is thriving. Our firm has closed nearly $5 billion in tax credit transfers in over 40 transactions. In our transactions, the top price is 97 cents on the dollar and the bottom price is 83 cents on the dollar. Much of the price difference depends on the quality of the indemnity backing the buyers purchase of the tax credits. At the high end of the range are indemnifiers/guarantors with investment grade or a tax credit insurance policy, while at the low end of the range are an unrated indemnifier not backed by tax credit insurance.
The Treasury released final rules on tax credit transfers, but “the credit” really goes to Sen. Joe Manchin (I-WVa.), who decided that such things were better handled by the private sector than the IRS. In contrast, activity around “direct payment” (i.e., a refund from the IRS) for tax-exempt project owners, clean energy component manufacturers, and carbon capture and hydrogen projects is anemic. Eligible participants are generally avoiding direct payment out of concern about the time it will take the IRS to process direct payment applications and potential cuts.
Tax credit transfers have been a success despite Treasury rules consistently favoring fiscal policy over encouraging clean energy. Examples include the approach of passive activity loss rules that limit individuals’ ability to purchase tax credits that is even stricter than the passive activity loss rules themselves: the transfer rules prevent an election to “bundle” hours for an individual to meet the active threshold, while the passive activity loss rules actually allow such an election for activities whose combination is a “suitable economic unit.”
In addition, Treasury regulations prohibit combining a pass-through lease investment tax credit election (also known as reverse leasing) with transferability (or direct payment), even though such an election is provided for in the tax code.
The other loopholes in the Treasury rules are (i) we dont know whether the IRS will audit the buyers or sellers of tax credits (sellers make more sense, but buyers have the money) and (ii) we dont know whether transaction costs for tax credit transfers are deductible.
Additionally, Treasury’s online registration portal is jammed, and Treasury is telling registrants that it cannot process 2024 registrations until October because it has 2023 registrations it needs to process before the extension that buyers and sellers of tax credits that accrued in 2023 have to file their 2023 tax returns in September for partnerships and October for corporations. The resourceful tax credit pass-through industry is finding ways around these issues.
One of the goals of the IRA was to democratize tax fairness. The IRA has made some progress in that direction, but it hasn’t quite succeeded. Lightly capitalized solar developers can access the tax credit transfer market by paying a tax credit insurer, a tax credit transfer broker, a law firm, and for investment credit transactions, an appraiser. Whereas well-capitalized solar developers can probably do so with a law firm, and for investment credit transactions, an appraiser. So well-capitalized developers are probably getting five cents or more on the dollar versus their light-capitalized competitors. That may not sound like much, but over time it adds up and puts the well-capitalized developers way ahead.
The 10% tax credit for projects built in “energy communities” appears to have been successful. For the most part, developers are able to determine whether their projects qualify for the 10% tax credit and are able to monetize the 10% tax credit in the tax credit transfer market. This is because the Treasury has issued relatively clear guidelines based on objective standards. In addition, we are seeing projects developed on closed coal sites and in communities with a history of significant fossil fuel use.
For now, the 10% local content surcharge is a split decision. The addition of local content appears to have spurred the construction of a flood of solar module and battery factories, but most of those factories are not yet online.
The original Treasury guidance on adding domestic content was unworkable. That is why safeguards were enacted for solar, onshore wind, and batteries. Safe harbors for solar and onshore wind appear workable. There is some optimism regarding the safe harbor for storage. Technologies such as geothermal heat pumps, fuel cells, renewable natural gas, and offshore wind do not currently have a safe harbor and are faced with uncertainty over how to determine eligibility for the domestic content tax credit add-on.
The IRA’s Failures
Let’s take a stiff drink and talk about the IRA’s failures. First, based on anecdotal evidence, the prevailing wage and apprenticeship rules are not creating much value for the nation. Most people building solar projects are already receiving wages not much different than the Department of Labor’s prevailing wage because of a shortage of skilled labor in the market. So the prevailing wage rules are saddling the solar industry with the worry that a mistake in its record keeping will result in large penalties or, worse, a reduction of the tax credits a project is eligible for by 80%, while not spurring higher wages for the skilled workers needed to build solar and other clean energy projects. It has created a cottage industry of consulting and accounting to verify that proper wages are being paid, but the country was already facing a shortage of accountants. Let alone a shortage of tax lawyers.
As for apprentices, it appears that most projects are taking advantage of an exemption from apprenticeship requirements because apprentices are not available. Thus, well-intentioned rules do not appear to be prompting young Americans to give up video games to learn a trade. Thus, apprenticeship rules create concern among project developers and their contractors about a costly tax credit slip-up, while failing to spur a trades renaissance. If solar and other clean energy technologies are necessary to save the planet from climate change, should we burden projects deploying these technologies with burdensome requirements that do not translate into more skilled craftspeople?
Finally, there is the proposed regulation on investment tax credits. These rules do not clearly answer some basic questions that the industry has been asking for years, such as how much of a solar parking shelter qualifies for investment credit. In addition, the Treasury has dared to require that all equipment in a project have a common owner and only allows tax credits for repairs and improvements if less than 20% of the improved project originates from the original equipment.
The investment credit rule, however, appears to have something of an unexpected gift in store. The Department of Energy (DOE) appears to have convinced Treasury to broadly interpret the investment credit rule for interconnection costs. The ostensible motive is to spur improvements to the nations aging power grid.
The statute provides a 5 MW threshold for the interconnection cost investment credit. However, the proposed regulations appear to indicate that this threshold applies at the investor level for solar and at the turbine level for wind. For example, it appears that a solar project that is believed by a majority of industry participants to have 200 MW of capacity (i.e., exceeds the 5 MW threshold) would be eligible for the credit, provided that no single investor serves 5 MW or more (e.g., there are 50 investors serving 4 MW each). This interpretation appears to have been confirmed by the proposed Section 48E regulations (i.e., the technology-neutral investment credit). However, many law firms tax opinion committees are conservative by nature and are waiting to bless "testament"-level opinions under traditional Section 48 until Treasury confirms the favorable interpretation in the final Section 48 regulations.
The implementation of the IRA has led to a range of policy outcomes. However, as is often the case, the most agile and creative have come out on top, while concerns about whether the nation is doing enough to address the existential threat of climate change remain. |
