Renewable Energy Tax Credit Transfers: Diligence and Negotiation Considerations

Key Takeaways: Renewable Energy Tax Credit Transfers: Diligence and Negotiation Considerations

Executive Summary

The webinar focused on the intricacies of tax credit transfers, particularly in the energy sector. Key speakers, including Doug Jones, Cal Dargan, Andrew Eastman, and Doug Kolker, discussed various tax credits such as the Investment Tax Credit (ITC), Production Tax Credit (PTC), and others under sections 48, 45, and 45Q. They explained the eligibility criteria, prevailing wage and apprenticeship requirements, and the impact of recent legislative changes like the Inflation Reduction Act and OB3. The session also covered the process of transferring tax credits, the importance of due diligence, indemnity considerations, and the implications of the Foreign Entity of Concern (FEOC) rules. The speakers emphasized the need for thorough documentation and risk mitigation strategies, including tax credit insurance, to navigate the complexities of these transactions.

Speakers

Kal Dargan, Partner, Husch Blackwell, kal.dargan@huschblackwell.com, 646.547.2957
Andrew Eastman, Partner, Husch Blackwell, andrew.eastman@huschblackwell.com, 314.345.6214
Doug Jones, Partner, Husch Blackwell, Doug.Jones@huschblackwell.com, 512.479.1178
Doug Kolker, Partner, Wipfli, doug.kolker@wipfli.com, 314.480.1324

Key Takeaways

1. Discounted Tax Liabilities: transferable tax credits allows companies to satisfy tax liabilities at a discount, typically ranging from 80 to 96 cents on the dollar.

2. Maximized ITC Benefits: investment tax credit (ITC) under Code Section 48 can start at 6% and go up to 50-60% if certain criteria, such as prevailing wage and apprenticeship requirements, are met.

3. Transferable Tax Credits: credit transferability, enacted under Code Section 6418, permits eligible taxpayers to transfer credits to unrelated taxpayers, with the transfer happening upon filing an election with the tax return.

4. ITC Recapture Risks: risks for ITCs and certain other credits require buyers to conduct thorough due diligence and often involve indemnity clauses and tax credit insurance to mitigate potential losses.

5. FEOC Compliance Necessity: Foreign Entity of Concern (FEOC) rules, effective from 2026, prohibit credits for projects receiving material assistance from entities associated with China, North Korea, Russia, and Iran, necessitating careful supply chain diligence.

Key Quote

Purchasing a transferable tax credit allows a company to satisfy tax liability for somewhere in the range of 80 to $0.96 on the dollar.

Related Content

Explore Related Content.

Webinar

Watch Full Webinar here.

FAQs: Renewable Energy Tax Credit Transfers: Diligence and Negotiation Considerations

General Information

1. What is the main topic of the webinar?
The main topic of the webinar is tax credit transfers, specifically focusing on energy incentives and the transferability of tax credits.

2. Who are the typical sellers and buyers of transferable tax credits?
The typical sellers are renewable energy project companies, manufacturers of renewable energy components, and utilities. The buyers are generally any entity with a U.S. federal tax liability, including corporations and other taxpayers, but not tax-exempt organizations.

Tax Credits Overview

1. What are some of the key tax credits discussed in the webinar?
Key tax credits discussed include the Investment Tax Credit (ITC), Production Tax Credit (PTC), Section 45Q for carbon capture, Section 45Z for clean fuel production, and Section 45V for hydrogen production.

2. What is the Investment Tax Credit (ITC) and how does it work?
The ITC, under Code Section 48, provides a credit starting at 6% and can go up to 50-60% for eligible energy systems. The credit is based on the cost of the project and can be increased by meeting certain criteria such as prevailing wage and apprenticeship requirements.

3. What is the Production Tax Credit (PTC) and how does it differ from the ITC?
The PTC, under Code Section 45, is based on the amount of energy produced by a renewable energy project over a period of time, rather than the upfront cost of the project. It is typically claimed over the life of the system.

Transferability and Direct Pay

1. What is the process for transferring tax credits?
The process involves the seller making a transfer election statement with their tax return, which allows the buyer to claim the credit. The transfer must be for cash and occur in the applicable tax year.

2. Can tax credits be transferred more than once?
No, tax credits can only be transferred once. After the initial transfer, the buyer cannot transfer the credit to another party.

3. What is direct pay and who is eligible for it?
Direct pay allows tax-exempt organizations to receive a payment directly from the government instead of transferring the credit. This is available for certain credits like the ITC and PTC.

Risk and Indemnity

1. What is recapture risk and who bears it?
Recapture risk refers to the possibility that the IRS may require repayment of the credit if the project stops producing energy or fails to meet other requirements. The buyer of the credit typically bears this risk, but indemnities and insurance can mitigate it.

2. What are some common indemnity considerations in tax credit transfer agreements?
Indemnity considerations include the scope of coverage (e.g., tax liability, interest, penalties), whether indemnity is on a pre-tax or after-tax basis, and the presence of caps on indemnity amounts.

Compliance and Diligence

1. What diligence is required when purchasing tax credits?
Diligence includes verifying the eligibility of the seller, confirming the project’s placed-in-service date, ensuring compliance with prevailing wage and apprenticeship requirements, and reviewing cost segregation reports for ITC or production reports for PTC.

2. What are the Foreign Entity of Concern (FEOC) rules?
The FEOC rules prevent entities from certain countries (China, North Korea, Russia, Iran) from claiming or transferring tax credits. Projects must also ensure that components from these countries do not exceed specified thresholds.

Blog: Tax Credit Transfer Strategies: Risk Management and Pricing Factors

Navigating the complexities of tax credit transfers can be a daunting task for businesses, especially those in the renewable energy sector. Understanding the nuances of tax credits, such as the Investment Tax Credit (ITC) and Production Tax Credit (PTC), is crucial for maximizing financial benefits and ensuring compliance with regulatory requirements. The ITC offers a base credit of 6%, which can increase to 30% if certain criteria, such as prevailing wage and apprenticeship requirements, are met. This credit is particularly beneficial for projects that commence construction before December 31, 2024, after which they transition to the new Code Section 48E. Similarly, the PTC provides credits based on the amount of energy produced, making it a viable option for long-term projects.

The intricacies of selling and buying these credits require thorough knowledge and strategic negotiation. This blog delves into the essential aspects of tax credit transactions, focusing on the roles of sellers and buyers, recapture risks, pricing mechanisms, and due diligence considerations. Understanding these elements can significantly streamline the process and help businesses navigate the complexities of tax credit transfers effectively.

Tax Credit Transfer Strategies and Risk Management

The transferability of tax credits under Code Section 6418 allows businesses to sell their tax credits to unrelated taxpayers, providing a financial tool for companies with insufficient tax liability. This is beneficial for renewable energy developers and manufacturers who can monetize their credits to improve cash flow. The process requires meticulous planning and adherence to specific rules, such as completing the transfer within the applicable tax year, ensuring the consideration is paid in cash, and documenting the transfer through a transfer election statement filed with the tax return. Credits can only be transferred once, highlighting the need for strategic planning and accurate execution.

Risk management is crucial in tax credit transfers due to recapture provisions, which require repayment of credits if the project fails to meet necessary criteria within a specified period. For example, the ITC has a five-year recapture period, while some projects involving foreign entities may face a ten-year period. Businesses often negotiate indemnities in their tax credit transfer agreements to ensure the seller compensates the buyer in case of recapture. Tax insurance can also cover potential liabilities from recapture or other compliance issues.

The introduction of direct pay options for tax-exempt organizations expands the utility of tax credits. This provision allows non-profits and government bodies to receive direct payments from the government instead of transferring the credits, simplifying the process and enabling them to benefit directly from the credits. The process requires pre-registration with the IRS and adherence to specific filing requirements, necessitating professional guidance and meticulous documentation.

In a tax credit transaction, the seller is typically the project owner generating the credit, and the buyer can be any party with a federal tax bill. Buyers use these credits to offset their tax liabilities. The transaction carries risks, particularly recapture risks, where the IRS may reclaim a portion or all of the credit if deemed invalid. Sellers generally pass recapture risk to buyers, but indemnity clauses and tax credit insurance policies can mitigate these risks.

Key Factors Influencing Tax Credit Pricing

Tax credit pricing is influenced by various factors, such as credit type and associated risks. Credits with recapture risks, like the Investment Tax Credit (ITC) and 45Q credit, have lower prices due to uncertainties. In contrast, credits like the Production Tax Credit (PTC), generated from projects already in service, are priced higher due to lower risk. Timing also affects pricing; forward purchases of credits carry higher risks and lower prices. Transfer agreements often include mechanisms to adjust for discrepancies between expected and actual credits generated.

Due diligence is crucial in tax credit transactions. Buyers must verify the seller's eligibility to generate the credit and ensure the project meets all criteria. This includes checking the project's existence, placed-in-service dates, and compliance with wage and apprenticeship requirements. Essential documents for verification include independent engineer reports, construction contracts, and interconnection agreements. Buyers should also seek indemnity clauses covering all potential tax liabilities, including interest and penalties, and ensure indemnities are provided on an after-tax basis to account for additional tax burdens.

The landscape of tax credit transfers and direct pay options offers substantial opportunities for businesses and tax-exempt organizations to enhance their financial strategies. By comprehending various tax credits, adhering to regulatory standards, and applying effective risk management practices, entities can utilize these financial tools to support renewable energy projects and other qualifying activities. Professional advice and rigorous due diligence are crucial for navigating this complex terrain, ensuring compliance and maximizing the financial benefits of tax credits.

Tax credit transactions necessitate careful planning and negotiation to benefit both parties while minimizing risks. Understanding the roles of sellers and buyers, recapture risks, pricing mechanisms, and due diligence considerations is vital for successful transactions. Indemnity terms protect buyers from potential losses, and thorough due diligence verifies the legitimacy of the credits. Addressing these elements allows parties to navigate the complexities of tax credit transactions effectively, ensuring financial benefits and compliance with IRS regulations.