Please note: the information below does not constitute legal, tax, or accounting advice. We are processing the new guidance rapidly and may make changes to our analysis over the course of the day and week ahead.
The U.S. Treasury Department released guidance on the transferable tax credits created by the Inflation Reduction Act on Wednesday.
The quick take-away is that the IRS has made transfers easier and greased the wheels of the credit transfer market. For example, the guidance largely immunizes credit buyers from meaningful recapture risk in the event a partnership ownership interest is sold. The guidance takes into account over 200 comments from the renewables and finance industry. While there are still some open questions that likely will be addressed after another round of industry commentary, we have a transactable market here.
On Wednesday, Deputy Treasury Secretary Wally Adeyemo said the direct pay and transferability provisions will "dramatically speed" deployment, bring governments and nonprofits to the table for the first time, and make it easier for businesses to benefit from the credits. "These new tools are also going to dramatically expand the reach of these credits to communities and organizations that are often left behind," he said. These statements build on previous statements by Assistant Secretary Batchelder that “direct pay and transferability are central to achieving our economic and climate goals.”
Join us: to help people navigate the guidance, we hosted a webinar with friends from the tax equity industry, legal, regulatory and tax experts – including M&T Bank, Foss & Company, and Allen & Overy. Watch the recording and read the recap.
Context on the Inflation Reduction Act transferability guidance
In August 2022, the Inflation Reduction Act was signed into law, making hundreds of billions of dollars of tax credits available to companies building facilities or producing clean power and materials. And, for the first time, these credits are transferable – creating a new and powerful market mechanism to fund energy transition projects. For a deep dive on transferable tax credits (TTCs), read our white paper.
Overall, the guidance provides helpful clarity on key issues. Specifically, the Notice of Proposed Rulemaking (NPR) and accompanying FAQ provide details on registration, recapture, divisibility, the use of partnerships, the tax treatment of proceeds from transactions, and the role of intermediaries. Generally, guidance is aligned with what was “priced in” to the market, but there are some meaningful “gives” that will make transacting more efficient.
The notice of proposed rule-making provides a 60-day comment period. Electronic comments are due by August 14 and a public hearing will follow on August 23. This provides an opportunity for the industry to provide further comments.
Ten top takeaways from Wednesday’s guidance
Highlights that will help streamline this market
- Clarity on filing mechanics and timing as well as how anticipated credits affect estimated tax payments of credit buyers (“transferees”). Sellers complete an electronic pre-registration of each project with the IRS, getting something akin to a project ID. Sellers and buyers complete a transfer election statement, including the registration number, which is attached to the seller and buyers’ tax returns. Importantly, “not all steps need to occur in the order displayed,” and “a transferee taxpayer may take into account a credit that it has purchased, or intends to purchase, when calculating its estimated tax payments.” This process principally affects filing and should not prevent deals from being signed and funded.
- Buyers are subject to a broad concept of recapture in the case a project is taken out of service, for example. BUT, recapture for buyers is limited in the sale of partnership interests. The FAQ says: “for transferred eligible credits…the transferee bears the financial responsibility for a recapture event…The transferor is required to notify the transferee if a recapture event occurs.” This was expected and ensures buyers act as a check on quality standards. Beneficially, the guidance indicates that partners can sell their interest in a partnership without triggering recapture for the transferee – although they would trigger recapture to the shareholder or partner who sold their interests. Specifically, the guidance says: “[t]he proposed regulations would clarify that ‘indirect’ dispositions do not result in recapture tax liability to a transferee taxpayer under section 6418.” Transferability was created to be an alternative to tax equity and should attract more buyers to the market who no longer need to be at-risk owners. These partnership rules limit one of the sources of risks that was present for buyers, and will likely unlock new buyers and reduce the complexity and cost of related insurance products.
- Tax credits are divisible vertically, meaning a proportional amount of the full credit is transferable (i.e., you can’t transfer adders alone). The FAQ states: “eligible taxpayers may transfer all or a portion of an eligible credit generated from a single eligible credit property. They may also sell an eligible credit generated from a single eligible credit property to multiple unrelated parties in the same tax year.” This was largely expected, but is a critical confirmation for the market. Divisibility allows buyers and sellers to rightsize credit amounts and – for buyers – allows for diversified portfolios. It also allows the building of syndicates of buyers for larger projects that otherwise might struggle to find a single buyer for their credits.
- Intermediaries can support transactions. The NPR states: “an arrangement using a broker to match eligible taxpayers and transferee taxpayers should not violate the no second transfer rule, assuming the arrangement at no point transfers the Federal income tax ownership of a specified credit portion to the broker or any taxpayer other than the transferee taxpayer.” While this clarification was mostly expected, the certainty will help create more liquidity in the market by providing clear parameters for financial institutions, syndicators, intermediaries, and platforms like Crux.
- Partnerships can buy and sell credits. A partnership or an S corporation may qualify as an eligible taxpayer or a transferee taxpayer, assuming all other relevant requirements in section 6418 are met. The guidance seems to be generally supportive of hybrid tax equity and transferable tax credit structures. It enables syndication mechanisms similar to those that exist in tax equity today: transferees can enter into partnerships and be allocated tax credits proportional to their partnership interest if the partnership buys transferable tax credits.
- Cash proceeds from the sale of credits are tax-exempt. Per the NPR, “amounts paid in connection with a transfer election by a transferee taxpayer are not includible in the gross income of an eligible taxpayer and are not deductible by the transferee taxpayer.” This will reduce the cost of capital going into renewables and decarbonization by narrowing the spread between buyers’ bids and sellers’ asks. Tax-exempt income related to sale is shared by partners in the manner the transferred credits would be claimed by the partners where a partnership is the eligible taxpayer.
- Advanced purchases are allowed. “A contractual commitment to purchase eligible credits in advance of the date a specified credit portion is transferred satisfies the paid in cash requirement, so long as all cash payments are made…within the period beginning on the first day of the eligible taxpayer’s taxable year during which a specified credit portion is determined and ending on the due date for completing a transfer election statement.” In the rapidly developing TTC market – like the tax equity market – one of the biggest challenges is the timing gap. Developers want to pull forward as much certainty and commitment as possible; buyers want to outlay cash as close to quarterly estimated payments as possible. Certainty around advanced commitments ensures that both objectives can be met, by allowing buyers to pre-commit to fund in the future and letting developers take those commitments to lenders and others to finance short-term needs.
A few areas to follow and that may require further clarification
- The pre-registration process is detailed. Temporary guidance establishes the process and Treasury is expected to open a portal by “late 2023.” There are two principal sources of risk that we see, as well as some upside, in the guidance as laid out. First, there is some risk that the delay in launching the pre-registration mechanism will slow deals this year among buyers who want to wait for pre-registration to transact. Market participants expect that deals closed prior to the portal being launched will need to go through the registration process after closing, which should not be limiting since the numbers are principally relevant to filing of 2023 taxes (which will occur in 2024). Second, there is some risk that the pre-registration “queue” gets backed up when it is launched, introducing more uncertainty and delays in transactions. However, once the system is in place, it should give buyers more clarity and certainty that the projects do exist and the credits are not being transferred multiple times. Tracking the pre-registration process may get complicated, particularly as Treasury has proposed requiring transfer election statements for each project. This will require significantly more streamlining, a place where technology like Crux can help.
- Active/passive rules are expected to apply, but further comments are requested. The NPR says: “a transferee taxpayer subject to section 469 would be required to treat the credits making up the specified credit portion as passive activity credits.” But, Treasury does request comments on “whether there are circumstances in which it would be appropriate to not apply the passive activity rules under section 469 to a transferee taxpayer.” We do not expect this to have a meaningful effect on the market since individuals are rarely tax investors. Many industry comments made the argument that active/passive rules may not be applicable. Specifically, commenters argued that individual buyers should be able to offset more types of taxes. The hope of the industry is to ensure sufficient offtake and a liquid market for the purchase of tax credits. The government collects significantly more revenue from individual income taxes than corporate taxes. So, the inclusion of individuals in the market would be expected to increase demand and prices.
- Base and bonus credits can’t be sold separately. From the FAQ: “[w]hile a taxpayer can transfer a portion of an eligible credit, a taxpayer cannot transfer a portion of an eligible credit related solely to a bonus credit amount. For example, the portion of an eligible tax credit related to the Domestic Context Bonus cannot be transferred separately from the rest of the eligible tax credit.” This will present complications since developers may, in many cases, reach certainty about eligible bonus amounts later in the process. For developers of projects whose projects may qualify but won’t know for a period of time, it is unclear whether they are supposed to wait to transact, or are limited to just getting commitments from buyers, which will fund after the final size of the adders is known. Nevertheless, the IRS provided flexible rules to sell credits for each “unit” (i.e., wind turbine or inverter string plus solar modules) in a project in different percentages.
Implications for partners and users of Crux – today and into the future
The guidance today reinforces Crux’ strategy and vision: this new market will require technology to manage complexity and attract substantially more buyers to the market.
At Crux, we’re building a network and tools for developers, tax credit buyers, advisors, and financial institutions to transact and manage clean energy tax credits – effectively serving as the connective tissue between everyone in the ecosystem to execute transferable deals. Developers on Crux will more easily find buyers at better prices. Buyers will have access to more credit opportunities with more transparency on the market. Financial institutions and other intermediaries can leverage tools to scale and streamline their syndication businesses.
There are a few areas of the Crux platform that we are doubling down on in reaction to this new guidance:
- Workflow software for syndication: The clarity on the ability for partnerships to sell the credits and intermediaries to support transactions further reinforces our conviction in the need for workflow software to support financial institutions and advisors to scale syndication. This is especially true in the context of the now-confirmed divisibility of credits that will lead to many more counterparties in transactions.
- A larger growing network of buyers in Crux: The supply of credits is about to explode and we need to dramatically increase the number of buyers. In response to the narrowing of recapture risk and the clarity of mechanisms for election and filing, we’re prioritizing a smooth onboarding experience for new buyers to guide them through the process of transacting.
- Pre-registration: Crux will build in necessary mechanisms to add registration numbers at the project level. With the added clarity on filing mechanism, in consultation with counsel and our users, we will explore adding functionality to manage the preparation of registrations and transfer election statements. This is especially important given portfolio financings will become more complex, with each project needing to be registered.
Transferability is the key mechanism to drive capital into clean energy and decarbonization projects. John Podesta, Senior Adviser to the President for Clean Energy Innovation and Implementation, said today that the ability to transfer tax credits “will help accelerate private sector financing and unlock literally billions of dollars of capital for clean energy projects.”
Today’s guidance offers clarity on the mechanisms needed to power the transferable tax credit market while reducing risk for buyers, sellers, and intermediaries. With these new details released, we expect transactions to rapidly accelerate over the coming months.
We’d love to hear more about your company’s questions, concerns, and goals surrounding transferable clean energy tax credits. Join our webinar with friends from M&T Bank, Foss & Company, Allen & Overy, and KPMG next Tuesday, June 20, at 12pm ET. Register here.