Pratt’s Energy Law Report has published our article 2018 and Onward: The Impact of Tax Reform on the Renewable Energy Market. We are pleased to be able to make a PDF version of the article available. (The article starts on page 6 of the PDF).
The Equipment Leasing and Finance Association has published our article The Impact of Tax Reform: What Leasing Companies Need to Know (subscription required). We are also pleased to be able to make the article available in PDF format. The article addresses equipment leasing generally, rather than being renewables or tax credit focused.
A Word About Wind has published our article What Is the Impact of Tax Reform on US Wind Tax Equity Deals? in its blog (subscription required) and newsletter. If you are unable to open the blog post, the text of the article is available below:
On 22 December 2017, President Trump signed the first major reform of the United States tax code since 1986. Here are some of the ramifications of the reforms on wind tax equity transactions.
Corporate Tax Rate Reduced to 21%
In 2018, the corporate tax rate has been reduced from 35% to 21%. The rate reduction means that US corporations will pay significantly less federal income tax, so the supply of tax equity will decline. However, most tax equity investors are expected to still pay enough tax to merit making tax equity investments.
Importantly, the rate reduction means sponsors of wind projects will be able to raise less tax equity as depreciation deductions are worth only $.21 per dollar of deduction rather than $.35 per dollar.
100% Bonus Depreciation
A partial mitigant to tax rate reduction is that the act provides the option of claiming 100% bonus depreciation (i.e. expensing), so depreciation deductions can be available in the first year (rather than over multiple years). However, the partnership tax accounting rules hamper the efficient use of 100% bonus depreciation. Continue Reading What Is the Impact of Tax Reform on US Wind Tax Equity Deals?
Below are soundbites from panelists at the Solar Energy Industries Association’s (SEIA) Finance & Tax Seminar in New York City. The seminar was held on June 1 and 2, but only comments from the second day are reflected below. The soundbites were prepared without the benefit of a transcript or recording and were edited for clarity. Further, they are organized by topic, rather than appearing in the order in which they were said.
Tax Equity Market in 2017
- It has been a slow start to the year. We will see a down year [compared to the $11 billion of tax equity funded in 2016]. – Executive Director, Energy Investing, Money Center Bank
- There is relatively smaller tax equity flow in 2017, but there is continued demand for good projects with experienced sponsors. – Director, Investment Fund Manager
- We saw a lag coming into this year. We haven’t seen a large uptick in investment. – Director, Structured Finance, Solar Services Company
Partnership Flip v. Sale-Leaseback Structures
- A partnership flip provides an attractive balance for a cash equity investor to invest at scale and earn an attractive yield. The structure is attractive to cash equity investors because it raises less cash than a sale-leaseback. [A cash equity investor is, generally, an investor other than the developer of the project. Such investors are eager to invest, but typically do not have tax appetite. Therefore, the partnership flip suits them well as it allows the tax equity investor to monetize 99% of the ITC, and much of the depreciation, while still requiring a significant cash equity investment.] – Director, Investment Fund Manager
Tax Equity Investors’ Reaction to the Possibility of Tax Reform
- We are putting into our documents cash sweeps for the risk of tax reform resulting in a lowering of the tax rate. – Business Development Officer, Retail Bank
- We want to be sure that if a tax law change occurs, we are protected with a step-up in our cash-sharing percentage or an indemnity. – Executive Director, Energy Investing, Money Center Bank
- There is the potential for a tax equity investor’s economics to improve with a reduction in tax rates, if the reduction occurs after the losses are used. – Director, Project Finance, Solar Services Company
Below are soundbites from speakers and panelists who spoke at Infocast’s Solar Power Finance & Investment Summit on March 22 and 23 in San Diego. It was Infocast’s best attended event ever, and the mood was relatively upbeat.
The soundbites are edited for clarity and are organized by topic, rather than in chronological order. They were prepared without the benefit of a transcript or recording.
Tax Equity Structures
“The tax equity flip [partnership structure] is more complicated, [than a sale-leaseback], in particularly if there is back leverage.” Director of Investing, Solar Company
“The optimal structure for C&I [for a partnership flip with back leverage] is 40 percent tax equity, 45 percent back leverage debt” and 15 percent sponsor equity. Director of Investing, Solar Company
“Last year it was almost universally inverted leases; this year mostly partnership flips.” Banker, Specialty Bank
“There is a more pronounced tension between back leverage and tax equity in an investment tax credit transaction, [than a production tax credit transaction,] because of the risk of recapture of the investment tax credit.” Managing Director, Tax Equity Investor
“There is increased tension between back leverage and tax equity, whether the stress is cash step ups for under performance or other matters. What we thought were normal structuring techniques the back leverage lenders take exception to.” Managing Director, Money Center Bank
Selecting a tax equity structure should be “all about velocity. Really, [the sale-leaseback] is what is easiest to do.” Managing Director, Regional Bank
“A cash strapped sponsor is not the best candidate for a partnership flip; they are better off with a sale-leaseback.” Executive Director, Non-Traditional Tax Equity Investor
“Some tax equity ask us to lend at the project level – senior secured – for capital account reasons. But by the time you negotiate the forbearance and related debt/equity terms, you might as well be back leverage.” Group Head, Regional Bank’s Capital Markets
“We only consider project level debt as a lender. We have negotiated dozens of forbearance agreements with tax equity.” Banker, Specialty Bank
State of the Tax Equity Market
“There is enough [supply of] tax equity for 2017 [projects]. We are seeing some 2018 transactions being pushed by developers into 2017.” Advisor, Boutique Accounting Firm
“We like to take our limited [annual] tax capacity and spread it over a greater volume of deals, so we prefer wind” which has a ten year production tax credit, rather than a 30 percent investment tax credit in the first year. Managing Director, Consumer Finance Bank
“In wind, you [(i.e., the tax equity investor)] are a bigger piece of the capital stack. In solar, it is smaller piece because the investment tax credit is all up front. [The sponsor] wants to minimize the tax equity to maximize the back leverage, which is cheaper capital.” Advisor, Boutique Accounting Firm Continue Reading Infocast’s Solar Power Finance & Investment Summit Soundbites
On October 31, 2016, the US Court of Federal Claims decided that Halloween was the perfect day to release its opinion in Alta v. United States, and the plaintiffs no doubt are enjoying this treat.
The case came about when the plaintiffs brought suit against the Treasury for the alleged underpayment of over $206 million in grants under section 1603 of the American Recovery and Reinvestment Tax Act of 2009. That section provides the owners of certain renewable energy projects with a grant equal to 30 percent of the specified energy property’s basis.
As the court aptly stated: “And therein lies the dispute.” Importantly, the court emphasized the general rule that “[b]asis, as defined in the IRC, is the cost of property to its owner” and, while there are “exceptions to the general rule that purchase price determines basis,” such exceptions did not apply under the facts of this case. Accordingly, the court found that the plaintiffs were entitled to the full amount of their grants and awarded damages equal to the shortfall plus reasonable costs.
The cases involved 20 plaintiffs, all of which were special purpose limited liability companies organized for the benefit of various institutional investors. For 19 of the plaintiffs, the purported basis was set via a sale of a wind project or an undivided interest therein to it from the developer that was followed by a lease back to the developer. For one plaintiff, the basis was set in outright sale from the developer to the plaintiff without a lease; that is, the plaintiff operated the project directly. All of the wind projects were contracted to Southern California Edison pursuant to a long-term fixed-price power purchase agreement (“PPA”). All of the projects were sold prior to their start of commercial operation.
The government, in denying payment of the full amount of the grant applied for, argued that basis should be calculated from “the value of each wind farm’s grant-eligible constituent parts and their respective development and construction costs.” Everything else would be categorized as either goodwill or going-concern value. Accepting the plaintiffs’ argument, argued the government, would mean accepting an inflated and improper number far in excess of what the assets would justify.
The plaintiffs’ determination of eligible basis was purchase price “minus small allocations for ineligible property such as land and transmission lines.” Continue Reading Court of Federal Claims to Treasury: “Basis Equals Purchase Price”
The Court of Federal Claims on October 28 entered judgment in favor of Alta Wind cash grant applicants awarding them collectively over $206 million for grants under Section 1603 of the American Recovery and Reinvestment Tax Act that the Treasury had declined to pay. The two page judgment is available at Alta Wind Judgment Oct 2016.
The judgment is clearly good news for the renewable energy industry and the many other cash grant applicants who Treasury awarded smaller cash grants than they applied for. Other project owners who were shorted by Treasury are likely to be inspired by this judgment to bring lawsuits in the Court of Federal Claims to recover the difference between what they applied for and what Treasury awarded.
There is a substantive judicial opinion that accompanies the judgment. That opinion is still under seal (i.e., is not publicly available), while the judge and the parties determine what text must be redacted from the public version in order to protect proprietary information.
Congress provided that the Section 1603 cash grant rules “mimic” the investment tax credit (ITC) rules in Section 48 of the Internal Revenue Code (the Code); therefore, the Court’s opinion is likely to provide the renewable energy industry and its tax advisers with clarification of how to determine the ITC eligible. In many renewable energy transactions, that basis results from a sale of the project at fair market value as confirmed by an independent appraisal. The opinion may provide some clarification as to the methodology and considerations to be used in such an appraisal.
The decision is likely to have more significance to the solar industry than wind projects, as wind projects typically claim the Code Section 45 production tax credit (PTC), which is 2.3 cents per Kilowatt hour of production during the first ten years of operation of the project; therefore, the amount of the PTC is not affected by the tax basis (or the fair market value of the project).
The Department of Justice can appeal the case to the Federal Circuit. Therefore, there may another chapter in this story that could potentially change the outcome. However, to the extent the Federal Circuit were to view the amount of the cash grant award as a question of fact then it will only overturn the decision of the Court of Federal Claims if the factual findings were clearly erroneous. Federal Rule of Civil Procedure 52(a)(6).
Below are soundbites from panel discussions on September 14, 2016 at Solar Power International in Las Vegas. The soundbites are organized by topic, rather than in chronological order, and were prepared without the benefit of a transcript or a recording.
Supply of Tax Equity Investment
“There are 32 tax equity investors in the renewables market, about 26 of those invest in solar.” — Managing Director from a Money Center Bank
“It is very challenging when syndicators are trying to bring in new investors. Each new investor takes nine to 15 months to work through its approval issues.” — Director, Renewable Energy Investments for a Commercial Bank
“We continue to see insurance companies get into the market. They like the asset. You might have newcomers that invest in 20 MW of projects in commercial transactions.” — Managing Director of a Boutique Financial Advisor
“There are more investors for solar than wind. Wind is limited to experienced project [financiers]. Overall there is enough tax equity capacity for solar.” — Managing Director of a Boutique Financial Advisor
“We prioritize tax equity investment opportunities based on:
- Basic project finance fundamentals – quality of the sponsor and its management team, the quality of the power purchase agreement (“PPA”), the quality of the equipment and its warranties, and pro forma stress tests.
- The minimum amount out the door. For solar, we want to be investing $75 to $100 million per transaction. If the transaction involves commercial and industrial or residential projects, we like it to take no more than six to nine months to deploy that amount.
- Repeat business. Does the sponsor have a pipeline of projects, so we can reuse the papers we have” negotiated. — Managing Director from a Money Center Bank
New Tax Regulations Curtail Pass-Through Lease Structure Benefit
The US Internal Revenue Service (IRS) recently released new proposed and temporary regulations addressing certain investment tax credit issues in a so-called “pass-through lease” structure. A pass-through lease is a structure in which the lessor of an investment tax credit-eligible asset makes an election to pass through the investment tax credit to the lessee of the asset, which lessee is frequently a partnership. The term “inverted lease” is sometimes used to refer to a pass-through lease structure in which each of the lessor and the lessee is a partnership, and the lessor and lessee partnerships are related to each other. The new regulations apply an “aggregate” treatment to partnerships (and S corporations) to ensure that any investment tax credit is appropriately taxable to the taxpayer that used the credit.
As discussed in more detail below, if a partner in a partnership that claimed an investment tax credit transfers its partnership interest during the deemed income period, these new regulations require the remaining income inclusion to be accelerated and to be recognized by the transferor. Further, under these regulations, the deemed income inclusion occurs at the partner level such that it does not result in an increase to the partners’ outside basis.
Although these temporary regulations are primarily directed at the structuring of historic tax credit transactions, the temporary regulations do have a limited effect with respect to solar transactions where the credit is passed through to a partnership (particularly the outside basis adjustment in the case of partnership lessees, as discussed below). Continue Reading New Tax Regulations Curtail Pass-Through Lease Structure Benefit
We are pleased to make available the materials from our June 29 tax equity seminar.
Here’s is the link to a PDF of the slides: Seminar Slides PDF.
The webinar audience submitted questions that we did not have time to answer. The questions were:
1. Why do balance sheet players have an advantage in obtaining power purchase agreements?
2. What size of transaction supports the cost of the work needed for pass through and inverted leases?
3. Is there clarity as to a “reasonable” level of developer, project management, legal fees and finance costs as a percentage of the cost of the project?
4. For SolarCity stated tax equity returns in 2015 referenced in the presentation, in your experience, what have you generally seen the range of allocations for returns to be?
Our answers are available here: Q&A Link