The Stratton Report has published an interview with me that discusses the pending tax reform legislation: http://strattonreport.com/longforms/davidburtonmayerbrown/.
David K. Burton is a partner in Mayer Brown's New York office and a member of the Tax Transactions & Consulting practice. He leads Mayer Brown's Renewable Energy group in New York. He advises clients on a wide range of US tax matters, with a particular emphasis on project finance and energy transactions. In addition, he also advises clients on tax matters regarding the formation and structuring of domestic and offshore investment funds.
The US tax reform bill that the Senate passed on December 2, 2017—along partisan lines in a 51 to 49 vote—is a mixed bag for the tax equity market. The bill is now headed to the conference committee, consisting of House of Representative and Senate leaders, to be reconciled with the tax reform bill passed by the House on November 16.
Below we describe the five differences from the House bill that are of greatest significance to the renewable energy tax equity market. (See also our prior analysis of the ramifications for the tax equity market of the House bill.)
Amounts of and Eligibility for Tax Credits
First, the amount of renewable energy tax credits available and the rules for qualifying for those credits are unchanged from current law under the Senate bill. Specifically, the inflation adjustment that applies to production tax credits is left in place and the “start of construction” rules are unchanged. The fact that the Senate bill left these provision alone is positive for wind and solar, which are in the midst of a phase-out, for wind, and a phase-down, for solar.
However, the Senate bill also left alone the lapsed tax credits for the “orphaned” renewable energy technologies that were inadvertently omitted from the 2015 extension that benefited wind and solar. The orphaned renewable energy technologies are fuel cells, geothermal, biomass, combined heat and power, landfill gas, small wind, solar illumination, tidal power and incremental hydroelectric.
Proponents of those technologies may have more negative views of the Senate bill. There is still discussion of the tax credits for the orphaned technologies being included in an “extenders bill” to possibly be taken up after the tax reform process is over. Continue Reading Senate’s Tax Bill’s Impact on the Tax Equity Market: Five Differences from the House Bill
Mayer Brown has launched its US Tax Reform Roadmap. The Roadmap includes a timeline of legislative events related to the current tax reform efforts and links to the documents that were passed, approved or introduced on those dates as well as links to Mayer Brown’s analysis regarding pertinent documents. It should be useful to have all of the legislative documents, and Mayer Brown’s analysis thereof, in one place and organized chronologically.
Our article Proposed GOP Tax Reform Would Curtail Tax Incentives for Wind and Solar is available from North American WindPower (no subscription required). The article includes a discussion of the politics of the Senate passing tax reform and a discussion of market implications; however, the discussion of the specific changes to the Internal Revenue Code is similar to our blog post GOP Tax Bill Proposes Changes to the Renewable Energy Industry’s Tax Incentives of November 4.
On Thursday, November 2, Republicans in the US House of Representatives released their proposed tax reform legislation, providing for massive alterations to tax law. The proposed legislation would trim tax benefits applicable to the wind and solar industries, while broadening the scope of the application of the “orphaned” energy tax credit. Further, it would eliminate the tax credit for electric vehicles starting in 2018. The proposed legislation is subject to further amendments and may not be enacted into final legislation.
Continuity of Construction. Pursuant to current law, the production tax credit (PTC) and investment tax credit (ITC) phase out over time, with the level of credit for which a renewable energy project qualifies being based on when the project began construction relative to various deadlines that determine the level of PTC or ITC. Under the proposed legislation, for any renewable energy project to qualify for a specific level of PTC or ITC, there would need to be continuous construction on such project from the deadline for the specific PTC or ITC level through the date the project is placed in service.
The concept of continuous construction does not exist in the current PTC and ITC provisions of the Tax Code. It was adopted by the IRS as an administrative matter in Notice 2013-29. However, the IRS later, under Notice 2016-31, created a safe harbor to enable projects to avoid application of the IRS’s “continuity” requirement. To qualify for the safe harbor, a project must be placed in service within four calendar years after the end of the calendar year in which construction began. The proposed legislation would effectively codify the continuity requirement and eliminate the safe harbor. Further, these changes appear to apply to all projects that have not been placed in service as of the date of enactment of the proposed legislation, regardless of whether construction of such projects began before enactment. Continue Reading GOP Tax Bill Proposes Changes to the Renewable Energy Industry’s Tax Incentives
The full text of the article is below or it is available at Solar Industry Magazine:
The solar industry has undergone a tremendous evolution in the course of the last decade. Below we outline some of the more notable developments, with a focus on project financing in the U.S.
In 2007, the largest solar photovoltaic project in the world was an 11 MW project in Portugal, called Serpa, that cost EUR 58 million to build. Today, the largest solar PV project in the world is Tengger Desert Solar Park in China and is 1,500 MW, or more than 100 times the capacity of Serpa, and the cost of building a solar project is a fraction of what it was a decade ago.
In 2007, manufacturers of thin-film solar and manufacturers of crystalline silicon solar were battling to see which would be the predominant technology. Today, there are more manufacturers of crystalline modules than thin film and more projects using crystalline modules than thin film; however, First Solar appears to have found success with rigid thin-film modules.
In 2007, terms like “resi,” “C&I,” “DG” and “community solar,” which are now ubiquitous in our industry, were unknown to most energy financiers. Continue Reading Solar Industry Magazine Publishes – A Decade of Evolution In U.S. Project Financing
Below are soundbites from panel discussions at Solar Power International in Las Vegas on September 11 and 12. The soundbites are organized by topic, rather than in chronological order, and were prepared without the benefit of a transcript or recording.
The topics covered are: Tax Reform • Tax Equity Volume and Investor Mix • Tax Equity Structuring • Deficit Restoration Obligation Structuring and Senior Secured Debt in Partnership Flips • FMV Valuation Issues and Insurance • Community Solar • Community Choice Aggregators • Power Purchase Agreements • Residential and Community Solar Markets • State Policy • Department of Defense Procurement
ITC has already gone through tax reform and already has a transition rule in place. These arguments resonate pretty well with Republicans. — SEIA, Gov’t Relations
Anyone who tells you where we are now in this tax reform debate, is lying to you. — Boutique Investment Manager
Low likelihood of comprehensive tax reform in 2017. Chances for a tax cut are pretty good. Indemnification for a tax rate cut is built into these transactions. — Boutique Investment Manager
We are using a 25% corporate tax rate in most deals. The specifics depend on allocation of risk [of change in tax law] and [the financial strength of] the counterparty. We are more likely to put in less capital now and contribute more later if there is not a tax rate cut. — Commercial Bank, Head of Business Development Energy Investing
Not one size fits all. We use a 35% tax rate for 2017 and a lower rate for 2018 and beyond. In our deals, for federal tax rates we use between 25 and 30% [for 2018 and later]. If rate reduction doesn’t occur, we then fund more. It frightened me when Paul Ryan said he was aiming for a 22.5% tax rate. [This was before the Republican Big 6 released their proposal with a 20% corporate tax rate.] — Money Center Bank, Managing Director
We have very flexible solutions in place now to address tax rate reduction risk in deals. It is not the headache it was six months ago. — Boutique Accounting Firm, Director
Since corporations generally pay less than 35% in federal taxes now, and $1 of tax credit is $1 of tax credit, it remains to be seen what a lower rate really means [for the solar tax equity market]. — Boutique Investment Manager
The potential change in tax rate means the potential for a cash sweep, which means sponsors can raise less back leverage. — Commercial Bank, Head of Business Development Energy Investing. Continue Reading Solar Power International 2017 Soundbites
My article The Dramatic Arc of the PTC was just published in North American WindPower and discusses the history of the production tax credit (PTC) from its original enactment to the phaseout. Here’s the text of the article:
The production tax credit (PTC) is the force that spurred the U.S. wind industry from an immaterial segment of power generation in the early 1990s to providing the fastest-growing job in America – wind turbine technician. At the end of 2016, the total wind capacity in the U.S. was more than 82 GW. Now, like the finale of a Fourth of July fireworks show, the PTC has several more exciting bursts to go and then will, in theory, peter out.
Many newcomers to the wind industry may be surprised to learn that the PTC was not born during the Obama administration or even the Clinton administration. Rather, the PTC was born in 1992, and its proud parents were Sen. Charles Grassley, R-Iowa, and President George H.W. Bush.
The PTC was originally $.015/kWh for the first 10 years of a wind project’s operations. However, the statute provides for an inflation adjustment. Accordingly, 25 years later, the PTC is $.024/kWh, a 60% increase since its inception in 1992, and will continue to be adjusted in future years. The inflation adjustment applies not only to new projects, but also to PTCs generated by operating projects that are still within their 10-year initial operating period.
The PTC’s life has been worthy of a soap opera. Every few years, it has been slated to lapse (the first time being in 1999), and it has, in fact, lapsed on multiple occasions. But like a soap opera character, the PTC was brought back to life through the valiant efforts of its fans (in Congress), while in other years, the PTC “entertained” the wind industry with the cliff-hanging suspense of a last-minute extension.
Other than its periodic reincarnation, there have been five highlight-worthy changes in PTC policy. The first was the American Jobs Creation Act of 2004 when Congress excluded the PTCs generated in the first four years of a project’s operation from the sinister “alternative minimum tax” rules. This change means that even tax equity investors with many other tax benefits on their tax returns that caused them to pay federal taxes at a rate of less than 20% could still receive full benefit for the PTC generated in the first four years of a project’s life. This change helped keep certain large tax equity investors in the market.
Second, in 2007, the IRS published Revenue Procedure 2007-65 that created a safe harbor for structuring wind tax equity partnerships. This revenue procedure provides the industry with clear structuring guidelines that facilitated a growth in tax equity transactions until the financial crisis hit in late 2008.
Third, Congress enacted the American Recovery and Reinvestment Tax Act of 2009 in response to the financial crisis. Congress recognized that economic losses due to the financial crisis, and their resulting impact on the tax appetite of financial institutions that act as tax equity investors, had virtually shut down the tax equity market and, accordingly, the U.S. wind industry.
To address the condition of the tax equity market, Congress provided the owners of new wind projects with the option to elect a 30% investment tax credit and then the option to receive a cash grant in the same amount from the Treasury in lieu of the investment tax credit. The cash grant was last available for wind projects placed in service in 2012.
However, the 30% investment tax credit election for wind continues to be available but is rarely selected by wind farm owners (other than in the case of offshore projects) due to the high capacity factors of today’s projects that have resulted from improvements in turbine technology.
Further, the Treasury cash grant program provided the wind industry with more drama. After an initial honeymoon period, the Treasury grew skeptical of cash grant requests and started to impose its own judgment as to the appropriate cost of wind projects (and other forms of renewables) and paid reduced cash grants based on the Treasury’s black box valuations. Not surprisingly, this led to litigation. The first wind projects to be litigated were the Alta Wind projects that were developed by the prominent developer Terra-Gen.
During the Alta Wind trial in a Perry Mason moment, it was determined that the government’s expert witness, an MIT professor, had failed to disclose that he published articles in communist East German publications. Due to this lack of candor, the judge disqualified the professor from testifying and precluded the government from replacing him with another expert witness. Not surprisingly, Alta Wind won the case, and the trial judge wrote an opinion that effectively constrained the government’s ability to second-guess the pricing of cash grant (and, presumably, the investment tax credit, too) renewable energy transactions. Alta Wind and the tax bar eagerly await the Federal Circuit’s opinion on the appeal.
Fourth, the American Taxpayer Relief Act of 2012 changed the 20-year-old standard to qualify for PTCs from a project having to be “placed in service” (i.e., operational) by the statutory deadline to “construction” having to “begin” before the statutory deadline. Initially, to qualify for the PTC, construction of the project had to begin before Jan. 1, 2014. This deadline was extended to beginning construction before Jan. 1, 2015, by the Tax Increase and Prevention Act of 2015.
Fifth, neither the 2014 nor the 2015 deadline ended up mattering because the Consolidated Appropriations Act, 2016 extended the start-of-construction deadline and codified a gradual phaseout of the PTC. This statutory change, in conjunction with generally favorable IRS guidance defining the meaning of “begun construction,” gave the wind industry certainty through 2020.
The longest final season
The phaseout provides that wind projects that “began construction” in 2016 (or earlier) are entitled to 100% of the PTC, or the full $.024/kWh; projects that begin construction in 2017 are entitled to 80%, or $.0192/kWh; projects that begin construction in 2018 are entitled to 60%, or $.0144/kWh; and projects that begin construction in 2019 are entitled to 40% of $.0096/kWh. Finally, under current law, there is no PTC for projects that begin construction in 2020 or later.
The key question is, what does it mean to “begin construction”? The IRS generously defined “beginning of construction” to mean spending 5% of the total cost of the project or undertaking “significant physical work,” which was based on rules the Treasury had published to specify eligibility for the cash grant program it administered.
Deep-pocketed developers (e.g., NextEra) opted for the objective 5% approach, as that could be easily implemented and documented with purchase contracts, invoices and wire transfers. However, lightly capitalized developers wanted to play, too, but could not write a check for 5% of the total cost of future projects. Therefore, they were left with the fuzzy “significant physical work” approach.
For a few months, tax advisors wrung their hands about the quantification of “significant.” Then, the IRS issued guidance that provided there is no minimum amount of work required, so long as the work was of the appropriate “nature.” The IRS guidance included useful examples of what types of work qualified – excavating turbine sites, building roads to be used for operations and maintenance purposes, and manufacturing a customized step-up transformation.
The only drawback in the IRS’ guidance is that it imposed a requirement not in the statute: A project owner upon starting construction had to “continuously” progress the project through to completion. This led to more handwringing among tax advisors as to the meaning of “continuous.”
The IRS eventually provided some relief and published a safe harbor that the “continuous” requirement would not be applicable so long as the project is in service on Dec. 31 four years after the year construction started; further, that fourth anniversary would not be deemed to be before Dec. 31, 2018, regardless of what work may have occurred prior to 2014. It is reported that between 30 GW and 70 GW of wind projects “began construction” in 2016. NextEra alone stated it “began construction” of 10 GW.
To meet the IRS’ four-year rule, those 30-70 GW will come online between now and Dec. 31, 2020. That will keep manufacturers, construction companies, developers, tax equity investors and their advisors busy for the next 40 months.
What we do not know is if developers, to any material extent, will continue to “begin construction” of additional wind projects between now and the end of 2019 in light of the progressively shrinking PTC, or was that 30-70 GW the last shot?
Final season plot twist
Finally, the wind industry is living through a plot twist of Donald Trump as president. Trump had opposed a wind farm in the vicinity of one of his golf courses and has criticized it for its intermittent nature and purported risk to birds.
Grassley – the father of the PTC – stepped up to protect his baby. At the confirmation hearing for Secretary of the Treasury Steven Mnuchin, the senator asked if Mnuchin supported allowing the PTC phaseout to run its course undisturbed. Mnuchin responded that he did. Thus, it appears the IRS will not be ordered to rescind or negatively alter its “begun construction” guidance, and the administration will not propose a repeal of the phase-out statute.
Now, the wind industry hopes for a wind-friendly Congress in 2019 and beyond and a wind-friendly president in 2021 and beyond. Such a president taking office in 2021 would be just in time to address what seems will be an inevitable lull following the last of the 30-70 GW projects that “started construction” in 2016 being placed in service by the end of 2020 to meet the four-year safe harbor. We can only imagine where the wind industry and tax policy will be in 2021, but history suggests the road there will be an interesting one.
The National Renewable Energy Laboratory (NREL), a federally-owned laboratory that is funded through the U.S. Department of Energy, recently released a report titled Wind Energy Finance in the United States: Current Practice and Opportunities. The report provides a thorough overview of the capital sources and financing structures commonly used in wind energy finance. Below are quotes from the report that are of particular interest to tax equity market participants. We applaud the authors for writing a comprehensive report on a topic that is extremely technical. Also, below we include comments clarifying certain tax or legal concepts referenced in particular quotes.
Wind Expansion in 2016
• By the end of 2016, cumulative U.S. wind generation capacity stood at 82.2 gigawatts (GW), expanding by 8.7 GW from 2015 installations levels. Wind energy added the most utility-scale electricity generation capacity to the U.S. grid in 2015 and the second most in 2016. Project investment in wind in the United States has averaged $13.6 billion annually since 2006 with a cumulative investment total of $149 billion over this time period. The investment activity demonstrates the persistent appeal of wind energy and its significant role in the overall market for electricity generation in the United States.
• Looking ahead, the near-term outlook for wind energy reported previously suggests a continued need for capital availability at levels consistent with deployment seen in 2015 and 2016. The market has shown the capacity to finance projects at this level using current mechanisms at economically viable rates; however, increased deployment could necessitate new sources of capital. Broad changes to the financial industry—such as the possibility of major corporate tax reform, the currently scheduled phase out of the PTC and ITC for wind, and, specifically, a change in the role of tax equity—could fundamentally reshape the predominant mechanism for wind energy investment. It is possible that financing practices may need to evolve, while the growing body of wind energy deployment and operational experiences could help to attract new market participants.
PTC and Accelerated Tax Depreciation
• The United States Federal Government incentivizes renewable energy projects principally through the tax code. As of this writing, wind technologies are eligible to receive either the production tax credit (PTC) or the investment tax credit (ITC) (one or the other, but not both) as well as accelerated depreciation tax offsets through the Modified Accelerated Cost Recovery System (MACRS).
• The tax credit incentives (the PTC and ITC) provide an after-tax credit on tax liabilities (i.e., the taxes paid) and thus are often described as dollar-for-dollar tax incentives. As of this writing the PTC is currently worth $0.024 for every kWh generated over a 10-year period while the ITC is structured as a one-time credit valued at 30% of eligible system costs. For projects to claim the aforementioned full PTC or ITC values, however, the project is required to have begun construction prior to December 31, 2016. Projects that begin construction in 2017 through 2019 are available for a reduced-value PTC or ITC. Continue Reading NREL’s Wind Finance Report Highlights
Below is the text of an article we published in Law360 on September 14. (The article is also available at Law360.)
On September 7, the Internal Revenue Service issued Revenue Procedure 2017-47 to provide a safe harbor for public utilities that inadvertently or unintentionally use a practice or procedure that is inconsistent with the so-called normalization rules. Before describing the revenue procedure, we first discuss the basics of normalization.
Normalization is an accounting system provided for by Treasury regulations that is used by regulated public utilities to reconcile the tax treatment of the investment tax credits (ITC) set forth in section 46 of the Internal Revenue Code of 1986 or accelerated depreciation of public utility assets under section 168 of the Code with their regulatory treatment.
Although the ITC generally was repealed with respect to “public utility property” (i.e., property that earns a regulated return set by a public utility commission (PUC) (which has different names in different states)) that was placed in service after 1985, normalization remains relevant with respect to the ITC due to the long economic useful lives of much public utility property. Thus, Revenue Procedure 2017-47 addresses the ITC, not because solar projects (or other renewable projects) that earn a regulated return would currently qualify for the ITC, but because public utility property up until 1985 qualified for the ITC and some of that property is still being used and included in utility rate-making calculations as described below.
Understanding normalization requires an understanding of certain fundamentals of rate-making for regulated utilities. As a general matter, a regulated utility is entitled to earn an after-tax return on its investments in its utility system. The PUC that regulates the utility then sets the rates paid by customers for the utility service (e.g., electricity) to allow the utility to earn that after-tax return on its investments. In setting those rates, the PUC must determine economic depreciation for the utility’s assets and “tax expense.” Continue Reading An IRS Lifeline To Public Utilities On Normalization