The Inflation Reduction Act of 2022 provides for the transferability of certain renewable energy tax credits, including the investment tax credit (ITC).Although transferability deal volume has certainly increased in the last year, the market remains in a state of growth.As additional guidance continues to be released by the Internal Revenue Service (IRS) and as the market continues to mature, below are various transferability insights both developers and investors should keep in mind as they consider entering into credit transfer transactions, including in respect of pricing, transaction costs and timing, federal income tax consequences to buyers and sellers of the credits, recapture and more.
We expect that interest in transferable credits will significantly increase as more and more investors begin to consider these types of transactions (especially given key initiatives to pursue transactions with a sustainability aspect).Overall though, we believe that this will remain a buyer-friendly market as relates to pricing and deal protection terms.
Key Insights
- The earlier one transacts, the greater the benefits to early buyers, as prices should be discounted further before the market fully develops (we are currently seeing buyers paying prices of around $0.90 per dollar of the ITC, inclusive of transaction expenses).
- 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 and an increase in the ability to transact on smaller transactions which would otherwise have been cost-prohibitive under a traditional tax equity investment structure.
- The buyer (or its owner(s) if a passthrough or disregarded entity) should be a US-taxable entity with US federal income tax liability; however, the transferred tax credits can only offset up to 75 percent of the buyer's total US federal income tax liability and taxpayers (other than those taxed as C corporations for US federal tax purposes) may be subject to at-risk and passive activity limitations on the use of the transferred tax credits.
- 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.
- Documentation in these transactions generally includes agreements containing representations and warranties regarding the seller's ability to sell the credits and the eligibility and quantity of the credits being sold, together with covenants regarding recapture and compliance with the procedural requirements of the IRA.
- 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 fulsome indemnity protections to be negotiated at the time that the transaction is executed.
- Tax credit insurance continues to provide an additional source of comfort for investors unwilling to rely solely on the creditworthiness of the sellers.
We will be watching the market closely to see where these trends eventually settle.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.