Tax Reform: Renewable Energy


Liam Donovan, Principal

H.R. 1: TAX CUTS AND JOBS ACT OF 2017 • Most significant overhaul of the tax code since 1986 • Limited direct impact on renewables per se

‒ BUT broader changes to business tax regime—particularly internationally—carry significant implications • Most changes present minor negatives for the sector, but important to judge in context of the tax reform process ‒ TCJA as enacted represents big improvement over both House- and Senate-passed legislation ‒ Relative anticlimax of final bill obscures wild three month ride


TAX REFORM QUESTION MARKS: KNOWN UNKNOWNS • Would Congress honor the terms of the PATH Act deal? ‒ As part of 2015 omnibus deal, Congress passed massive extenders package ‒ Set long-term trajectory for wind and solar credits


TAX REFORM QUESTION MARKS: KNOWN UNKNOWNS (CONT’D) • Would orphaned technologies be restored to the ITC phaseout? ‒ PATH Act did not address other technologies that were eligible for PTCs & ITCs ‒ Credits for geothermal heat pumps, fuel cell property, combined heat and power, small wind, and others all lapsed at the end of 2016



‒ Revived orphan tax credits & harmonized them with wind and solar ‒ Restored parity for renewable technologies; provided certainty for future • Bad News ‒ Eliminated the inflation adjustment for wind PTC (prospectively) o Limits credit to base value of 1.5¢/kwh, a 60% drop » Effectively pares PTC back to 1993 levels ‒ Codified “continuous construction” requirement for PTC/ITC eligibility

o Amounts to effective repeal of 5% safe harbor under existing IRS guidance » Retroactively removes the option most developers use to qualify for the credit ‒ Repealed ITC after 2027 o Current law provides for permanent 10% credit for certain solar/geothermal property





















1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 ¢/kwh


SENATE TAX BILL: NO NEWS IS GOOD NEWS… FOR WIND & SOLAR • Senate bill contained no energy title  status quo prevails

‒ Inverted House dynamic: silence good for wind & solar, bad for orphans ‒ Somewhat surprising: Senate viewed as more friendly to renewables

o Rs feared messy fight over energy credits in committee could bring down bill » Grassley demanded biodiesel extended be included; opened doors to cats & dogs

• BUT proposal also introduced unknown unknowns ‒ Broader provisions not directed at energy nonetheless created new exposure o Unexpectedly retained alternative minimum tax, jeopardizing value of PTC » PTC can be used to offset AMT liability, but only for first 4 years o New international minimum tax on “base erosion payments” to related foreign parties » Renders PTC/ITC worthless for many taxpayers with significant international operations ‒ Taken together, presented existential threat to tax equity market


RECONCILING DIFFERENCES • Many expected the House to take up whatever the Senate could pass ‒ Slim majority & procedural hurdles made Senate lowest common denominator ‒ Ill-fated ACA repeal effort demonstrated the tension • House demands for conference won out after late Senate hiccups ‒ Senate passed bill in the wee hours with ink barely dry; not fully baked o Entire corporate community pushed back hard on return of AMT o Renewable energy & tax equity industries pushed back hard on BEAT tax formula • Final conference report close to Senate bill, but with key concessions ‒ Corporate AMT fully repealed ‒ ITC & PTC allowed to partially offset BEAT liability


THE FINAL ACT: • Amounts of tax credits remain the same. ‒ Inflation adjustment for PTC remains, and ‒ Phase-in schedules for both PTCs and ITCs stay the same • No codification of continuous construction ‒ IRS safe harbor remains effective. • BEAT provisions in the Senate bill were adopted with significant improvement for the renewable energy projects. • No extension for the “orphaned projects”.


WHAT ABOUT THE ORPHANS? • Ultimately fell out of tax bill, but lapsed credits not dead yet • Chairman Hatch dropped extenders package in late December ‒ S. 2256 provides for: o Extension/harmonization of orphan techs to PATH Act deal & phase-out schedule o 2-yr/retroactive extension of remaining expired/expiring credits • Expected to ride on gov’t funding vehicle, but caught in logjam ‒ Extenders need omnibus, but no omnibus without deal on spending caps ‒ No deal on spending caps without a deal on DACA/DREAMers o Also in mix: ACA stabilization/health extenders/CHIP reauth/disaster relief funding » Don’t forget: debt ceiling looms in February o Gov’t poised to shut down without a short-term CR by 1/19 » Likeliest scenario: some sort of deal on an omni (or long-term CR) by mid/late-February


BEAT: BASE EROSION ANTI-ABUSE TAX • BEAT ‒ essentially imposes a minimum tax on multinational corporations. ‒

it measures the difference between this imposed minimum tax and the corporation’s regular tax liabilities as reduced by tax credits other than those that are carved out. If there is a positive difference, the taxpayer will pay that amount as base erosion tax to the IRS. ‒ Unless they are carved out from this formula, any tax credits that reduce the corporation’s tax liabilities below the imposed minimum tax will be clawed back in the form of the base erosion tax. ‒ The imposed minimum tax equals []adjusted taxable income (5% in 2018, 10% from 2019 to 2025, 12.5% in 2026 and thereafter), ‒ The tax credits that are carved out from the formula and thus can offset BEAT liabilities are o Research tax credits and o 80% of low income housing credits, 80% of PTCs and ITCs • 20% of PTCs and ITCs may be clawed back. ‒ Since only 80% of PTCs and ITCs are carved out, 20% of PTCs and ITCs are potentially subject to the claw-back. ‒ This is an improvement from the original Senate bill which would have subjected 100% of PTCs and ITCs to BEAT, but does not provide a complete exemption. • Furthermore, these carvouts are only applicable to taxable years before 2026. In 2026 and thereafter, the regular tax liabilities are reduced by all tax credits. ‒ Furthermore, these carve-outs are only applicable to taxable years before 2026. In 2026 and thereafter, no carve-out for any tax credits. ‒ Means that all of the PTCs and ITCs claimed by a taxpayer may be clawed-back as BEAT by the IRS.


BEAT: OFFSETS AS EXTENDERS • Bill structured to elide reconciliation constraints ($1.5T over 10yrs) ‒ Costly measures sunset, rates for new int’l taxes ratchet up in 2026 o BEAT rate increases to 12.5%, specified credits no longer able to offset after 2025 » This is mostly a revenue gimmick; likely that Congress would be pressured to extend 80% offset • Would amount to a true international AMT—R&D/PTC/ITC/LIHTC all worthless against BEAT » BUT trying to guess who will control Congress in 2027 is impossible, much less what they’ll do • Either way, probably hinges more on broader appetite to extend individual title • Entire individual title (including family, business & estate provisions) expires after 2025

• Expect immense pressure to extend tax cuts for “the middle class” • See e.g. “fiscal cliff” of 2012 that extended 95% of Bush-era cuts • X-factor: politics of new pass-through deduction (199A)


BEAT: • BEAT does not affect all taxpayers in all taxable years. • It only applies to certain corporations ‒

BEAT only applies to large corporations, with average annual gross receipts of at least $500 million for the past three years, and • BEAT applies to such a corporation only in a year when its “base erosion percentage” is 3% or higher. ‒ Since this tax is intended to prevent big multinational corporations from reducing their US taxes by “stripping” their U.S. earnings through deductible payments to foreign affiliates. ‒ the “base erosion percentage” measures the deductible cross-border payments made by the corporation to its foreign affiliates, relative to ‒ Such corporation’s total deductions for the taxable year. • As a result, big multi-national corporations with significant foreign operations are most likely to be affected. ‒ Such as U.S. subsidiaries of foreign banks, ‒ or U.S. corporations with foreign affiliates. ‒ Corporations with only U.S. operations and no foreign affiliates will not be affected. ‒ Thus the effect of this provision on the tax equity market would depend on how many tax equity investors will be affected.



• No grandfathering rules for existing operational projects funded before 2018. PTCs and ITCs derived from those project could be subject to BEAT • BEAT may reduce the availability of tax equity capital. ‒ Because 20% of PTCs and ITCs may be clawed back, BEAT may reduce the availability of tax equity capital. • BEAT creates the risk of uncertainty. ‒ This is because a corporation doesn’t know whether it would be subject to BEAT in a given year until the end of the year when it has all the information to calculate its income, regular tax liabilities and base erosion percentage. ‒ It is especially troublesome for wind projects claiming PTCs because PTCs are generated for 10 years, and it is hard to predict how BEAT would apply over the life of the project. ‒ Thus for deals with tax equity investors that could be subject to BEAT, we expect to see a lot of negotiations around the allocation of this risk of uncertainty. ‒ There are a few structures that could be employed to mitigate or allocate this risk of uncertainty. • Wind projects can elect to receive ITCs in lieu of PTCs. o ITCs are claimed in the year when the project is placed into service, and it is easier to predict whether BEAT would apply in one year, as opposed to over 10 years for PTCs. o However, given the current production capacity of wind projects relative to its capital costs, claiming ITCs will likely reduce the amount of the available tax credits. • Wind PTC projects can also employ a modified pay-go structure o In pay-go structures, the tax equity investor only puts in a portion of its committed capital upon front o and in the traditional paygo, the investor invests the rest overtime based on the PTCs produced regardless of whether the investor has tax liabilities to use the PTCs; o whereas in the modified pay-go structure, the investor would only pay for any PTCs generated that are not clawed-back under the BEAT. o Compared to the traditional paygo structure where d takes only p r, the modified paygo would subject the d to both the production risks and the investor’s BEAT risk that it has no control over. • Where the market ends up with the allocation of the BEAT risk would depend on the leverage of the tax equity investors vs the developers. ‒ More tax equity capital than available projects, the investors would likely bear more BEAT risks ‒ More projects than available tax equity capital, the developers would likely cover more BEAT risks for the investors.


CORPORATE TAX RATE REDUCTION • Corporate tax rate is reduced from 35% to 21%. ‒ After the BEAT provisions, the corporate rate reduction is the second biggest provision affecting the renewable sector. • To profitable renewable energy projects, like any other profitable business, the effect of the reduced tax rate is of course positive on the after-tax cash flow. • But the effect on the tax equity market is mixed. ‒ It may reduce the available tax equity capital. Tax equity investors invest in renewable projects to receive tax credits and deductions to shield their federal income taxes. If their income tax liabilities decrease as a result of the reduced corporate tax rate, so would their appetite for renewable projects. So everything else being equal, a reduced tax rate would mean less available tax equity capital. ‒ Pricing of the tax equity would also be affected because the return of the tax equity investor is measured on an after-tax basis. More detail on the next slide.


CORPORATE TAX RATE REDUCTION: EFFECT ON THE PRICING OF TAX EQUITY CAPITAL • The return of tax equity investors is measured on an after-tax basis and consists of three components. ‒ The after-tax benefits of tax credits. ‒ of tax losses (generated e.g. from depreciations and interest deductions). ‒ of cash distributions. • The after-tax benefits of tax credits: not affected by the lower tax rate. ‒ $1 of ITC/PTC offsets $1 taxes, not affected by the rate. Limited by BEAT. • The after-tax benefits of tax depreciation/deduction: negative impact. ‒ Unlike tax credits, tax depreciation does not offset tax liabilities dollar for dollar. Instead tax depreciation reduces taxable income. After-tax benefit of depreciation is the product of the effective tax rate TIMES the amount of tax depreciation. o $100 tax depreciation » After-tax benefit to the tax equity investor would be $35 under 35% tax rate. » After-tax benefit to the tax equity investor would be $21 under 21% tax rate. o Thus in calculating the tax equity investor’s return from the project, the same amount of tax depreciation generates less after-tax return to the investor under a lower corporate tax rate. • The after-tax benefits of cash distribution: positive impact. ‒ After tax return of cash distribution is increased because of the lower tax rate • Effect on existing projects: ‒ Tax depreciation is taken in the first few years of the project – the earlier the project is in its life cycle, the more effect the lower tax rate will have on the project. ‒ For existing projects that have already exhausted the tax depreciation, the lower rate may produce ‒ For existing projects that have not already exhausted the tax deprecation, there may be some ripple effect because a larger share of cash likely will need to be distributed the investors to reach its expected return. This will affect cash available to service project debt, or pay equity distribution to developers service back-levered debt.


100% BONUS DEPRECIATION • Qualified personal properties acquired AND placed in service after September 27, 2017 and through 2022 are eligible for the 100% bonus depreciation. ‒ After 2022, the amount of bonus depreciation is phased down by 20% each year through 2026. ‒ 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026 and none thereafter. • 100% bonus depreciation also applies to used properties “acquired” and placed into service by the taxpayer ‒ One significant difference from the previous bonus depreciation rule is the elimination of the original use requirement. So newly acquired used property would qualify. o Used property is not eligible for bonus depreciation if it is acquired from a related party (generally 50% or greater ownership test), o Or if it is acquired in a tax-free transaction. o “Used property” qualifying for bonus depreciation will benefit operational projects current on the market for sale. ‒ For properties acquired in 2017, it is important to determine when the property is “acquired”. o Not eligible for 100% bonus depreciation if acquired before sept 27, even if it is placed into service thereafter. o Not by the closing date, but when a binding written contract is first put in place. o Turbine supply agreement acquired before September 28, 2017 but placed in service thereafter. ‒ Not available to business not subject the limitation on interest expense (real estate, regulated utilities).


100% BONUS DEPRECIATION • Election out and Transitional Rule: ‒ Taxpayers can opt out of the 100% bonus depreciation and instead depreciate an asset using its regular schedule (5 years for wind and solar assets). • (judged by history) the 100% bonus depreciation may have a marginal effect on renewable energy projects. ‒ When the 50% bonus depreciation was available, the tax equity investors have mostly been uninterested in taking advantage of that and have mostly opted out of the 50% bonus depreciation. ‒ Partly this is because the tax equity investors have a finite amount of tax capacity of absorb tax credits and depreciation and they would rather spread that scare resource over multiple projects. ‒ Another reasons is that in a partnership flip structure, allocation of partnership losses generated from tax depreciation is limited by the tax equity investor’s capital account balance. o When capital account balance starts with the investor’s invested capital, and is decrease by allocation of losses. When the capital account is zero, no depreciation can be allocated to the investor, unless the investor assumes a “deficit restoration obligation”, meaning that the investor will commit to pay back the partnership an amount equal to any excess allocation of depreciation. ‒ In 2017, in anticipation of the tax rate decrease (which would decrease the after-tax benefits of depreciation as we discussed), more projects have elected to take bonus depreciation before the tax rate goes down in 2018. o Now that the new lower rate started to apply, the market is expected to go back to the norm. i.e. less projects will elect the 100% bonus depreciation for the reasons stated above. • The sale-lease back structure provides better opportunities to monetize the tax benefits of the 100% bonus depreciation.


INTEREST DEDUCTION LIMITATION • Interest deductions limitations

‒ Limited to 30% adjusted taxable income (generally 30% EBDITA before the end of 2021 and EBIT after 2021). ‒ Discussed the mechanics. With respect to the renewable energy projects, the difference in the project level debt and the back-levered debt should be noted. • Project level debt ‒ Taken out by the project company. ‒ In a flip structure, the project company is a partnership for tax purposes, and the limitation applies at the project company. ‒ Interest deduction is limited by the project level income. ‒ Any limitation on the interest deduction will negatively affect the after-tax return of the project. o Project sponsors may replace project level debt with equity or try to increase partnership level income by aggregating different projects. • Back-levered debt ‒ Taken out not by the project company, but by the sponsor/developer. ‒ Tax equity investors in a partnership flip structure often don’t like project level debt because they view themselves as a financing provider and like any debt that is senior to their tax equity investment. ‒ Back levered debt will be subject to interest deduction limitation at the developer level.


PREPAID POWER CONTRACTS • Under a prepaid power contract, the offtaker pays the supplier in advance for a share of the electricity to be delivered under the contract. ‒ Often in municipal utility purchaser or electric cooperatives and rooftop solar projects. • Before TCJA, the supplier of the electricity can defer the inclusion of the prepayment for tax purposes by reporting such payment over the period the electricity is delivered. ‒ Supplier of electricity does not have to report income when the prepayment is received. ‒ Rather, it reports taxable income over the entire period the electricity is delivered. • The TCJA disallows such deferral for “goods and services” identified by the IRS. ‒ TJCA requires such prepayment for “goods and services” to be reported immediately as income, or at best, partly in the year the prepayment is received and the balance in the year after. ‒ Even though not identified specifically yet, it is expected that electricity will be covered by this provision.


REPEAL OF PARTNERSHIP TECHNICAL TERMINATION • Before TJCA, a partnership would be treated as terminated for federal income tax purposes if 50% or more of the partnership interest is transferred within the year ‒ All depreciation will be restarted which will result in less depreciation each year after the termination. The total amount of depreciation is not reduced, but it is taken over a longer period of time, thus reducing the net present value of the depreciations. • Limitations on the transfer of partnership interests to avoid technical termination are no longer necessary. ‒ In partnership flip structures, restarted depreciation would reduce the after-tax return of the tax equity investors. ‒ Provisions are carefully negotiated to restrict transfers that would result in such a termination and also to make the tax equity investors whole if such a termination occurs through indemnification.

‒ These provisions will not be necessary. • Tax planning tool becomes obsolete.

‒ For assets held in partnership form before the tax equity investor comes in, and the tax equity funding results in a technical termination of the partnership, then the new partnership is eligible for the bonus depreciation.



LIAM P. DONOVAN Principal Washington, DC +1.202.828.5847

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