We were pleased to participate in Power Finance & Risk’s (PFR) Tax Equity Roundtable. We were joined in the roundtable discussion by Rich Dovere of C2 Energy Capital, Marshal Salant of Citi, Kathyrn Rasmussen of Capital Dynamics Clean Energy and Infrastructure, Pedro Almeida of EDP Renewables North America and as moderator PFR’s editor, Richard Metcalf. The topics covered included tax equity structuring, tax reform, tax equity syndication and the challenges and opportunities associated with distributed generation solar. We are pleased to be able to make available to our readers PFR’s report: PFR Tax Equity.
Mayer Brown’s David K. Burton and Jeffrey G. Davis both Tax Transactions & Consulting partners and part of the firm’s Renewable Energy group co-hosted a heavily attended webinar on how tax reform is impacting the tax equity market and certain renewable energy structures with Vadim Ovchinnikov, CFA, CPA and Gintaras Sadauskas of Alfa Energy Advisors. Topics addressed, included: The latest industry trends such as, the feds raising interest rates; the increase in project M&A activity for both development and operating assets; plans for large offshore wind projects in several east coast states; changes in PPA’s and revenue models; compressed margins and why developers and investors are moving towards commercial and industrial (C&I) solar projects. Additional topics, included:
- New bonus depreciation rules and impact on tax equity transactions and modeling;
- Compressed financing margins for wind and solar;
- Strategies for “starting construction” to qualify for the maximum investment tax credit and rules for transferring safe harbored equipment between wind projects; and,
- An overview of HLBV GAAP accounting for tax equity investments as a challenge for public companies.
Over 480 clients and contacts registered for the co-hosted webinar. Due to the volume of interest and post-presentation questions, we would like to share the slides from the presentation: webinar presentation.
We are reviewing and preparing responses to all of the questions that were submitted electronically during the webinar. We will be sharing those questions with our answers in a subsequent blog post.
Below are soundbites from panelists from the Renewable Energy Finance Forum (“REFF”) Wall Street on June 19 and 20. The mood was upbeat. There were many references to a “wall of cash chasing projects” as a metaphor for how competitive it is to win bids to finance or purchase projects.
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.
The topics covered include the tax equity, debt and M&A markets, C&I solar, offshore wind, bonus depreciation, storage, YieldCos and others.
Tax Equity Market
“Solar tax equity is 30 to 38 percent of the capital stack of a project. Wind tax equity is 47 to 62 percent of the capital stack of a project.” – Managing Director, Boutique Investment Bank
“We are seeing a lot more wind. We are using our tax equity capacity in wind in 2018. Solar is looking good for 2019 and beyond.” Managing Director, Trust Company
“This year we will invest more in wind than in solar.” – Managing Director, Money Center Bank
“We are seeing tax equity portfolios that are seasoned trade in a secondary market. [Generally These are tax equity portfolios] that haven’t flipped on time or that [have the benefit of material cash distributions] but not tax” credits. – Managing Director, American Multinational Financial Services Company
“There is more tax equity now than there was before tax reform.” Managing Director, REIT
“2018 is a slow down due to tax reform and tariffs.” Managing Director, National Bank
“There is a lot less tax equity capacity due to the lower tax rate.” – Managing Director, American Multi-National Investment Bank
[Explained: there may be more tax equity investors in the market than last year; however, last year the corporate tax rate was 35 percent, and this year it is 21 percent, so a typical tax equity investor has 40 percent less tax appetite (and ability to invest in tax equity) in 2018 than it did in 2017.]
“If you are in BEAT [(i.e., the base erosion anti-avoidance tax in enacted as part of 2018 tax reform)], you cannot compete in tax equity. A couple of investors were hit with BEAT and exited.” – Managing Director, American Multi-National Investment Bank
“We get ten requests for tax equity a week and say ‘yes’ to less than one a week. We have to prioritize opportunities.” – Managing Director, American Multi-National Investment Bank Continue Reading Renewable Energy Finance Forum Wall Street Soundbites: the Tax Equity, Debt and M&A Markets, etc.
Many developers of renewable energy projects have experienced higher than expected transaction costs. There can be a wide range of reasons for such overages. One all-too-common reason is project documents that cause tax tensions. These tax tensions lead to more lawyer time, which leads to higher transactions costs. Thus, developers concerned about transaction costs should negotiate “tax-friendly” project documents to streamline the tax equity investor’s diligence process.
Project documents are typically presented by the developer to the tax equity investor’s counsel in executed form. Counsel then reviews these to ensure consistency with the tax analysis of the transaction and for other issues. When counsel identifies an apparent glitch, she typically tries to rationalize or mitigate it without requesting an amendment to the project document in question. That analysis can take some time. If she cannot find another solution, she will propose an amendment. It takes time to prepare the amendment and often more time to persuade the applicable counter-party to sign it. That request can then lead the counter-party to propose alternative language and a time-consuming (i.e., expensive) back and forth process.
Below is a list of tax issues for developers to keep in mind as they negotiate project documents. The list is intended to provide trail markers for the most direct path for developers who would like to streamline the tax diligence process (and the associated costs) for their project documents. The list is not intended to be all-inclusive. Further, the list is not to suggest that missing one or more of these is necessarily fatal to the tax analysis because (i) there are often multiple paths to reach the desired tax outcome and (ii) some of these are best practices, rather than fatal flaws. Below is generally intended for wind or ground mounted solar projects, as roof-mounted solar is a somewhat different animal.
There are typically five “project documents” (i) the power purchase agreement (“PPA”) or other revenue contract; (ii) the site lease or other right (which is sometimes combined with the power purchase agreement) to use the ground or roof on which the project is constructed; (iii) the interconnecting agreement that enables the project to transmit its power to the grid; (iv) the operations and maintenance agreement; and (v) the construction contract. Continue Reading Lower Transaction Costs with Tax-Friendly Project Documents
On June 22, 2018, the IRS released Notice 2018-59 (the “Guidance”). The Guidance provides rules to determine when construction begins with respect to investment tax credit (“ITC”) eligible property, such as solar projects. The Guidance was much awaited by the solar industry because the date upon which construction begins governs the determination of the percentage level of the ITC, which is ratcheted down for projects that begin construction after 2019.
In addition to applying to solar and (fiber-optic solar), the Guidance applies to the following energy generation technologies: geothermal, fuel cell, microturbine, combined heat and power and small wind.
Overview of Beginning of Construction
The ITC percentage for a solar project is determined based on the year in which construction of the project begins, provided the solar project is also placed in service before January 1, 2024, as follows: (i) before January 1, 2020, 30%, (ii) in 2020, 26%, (iii) in 2021, 22% and (iv) any time thereafter (regardless of the year in which the solar project is placed in service), 10%.
The Guidance is quite similar to existing guidance for utility scale wind projects. The utility scale wind guidance is discussed in our 2016 Update. As expected and consistent with the wind guidance, the Guidance provides two means for establishing the beginning of construction of a solar project (and other ITC technology projects): (i) engaging in significant physical work either directly or by contract the “Physical Work Method”) or (ii) paying or incurring (depending on the taxpayer’s method of accounting) five percent of the ultimate tax basis of the project (the “Five Percent Method”). As is the case with wind, the Guidance provides that the IRS will apply strict scrutiny of the facts and circumstances to determine if the project was continuously constructed from the deemed beginning of construction date through the date the project is placed in service.
Four Year Placed-in-Service Window
The wind guidance provides a four year window for the project to be completed and to avoid the scrutiny as to whether the construction was continuous. There had been speculation that the window for solar (or at least some classes of solar) would be shorter because the time to construct solar projects (especially rooftop solar) is generally shorter than the time to construct a wind project. In what is a relief to the solar industry, the Guidance provides solar, and the other ITC technologies, a four year window as well. Continue Reading Beginning of Construction Guidance for Solar and Other ITC Technologies
In a recent case, the Tax Court ruled in the taxpayer’s favor as to three California distributed generation solar projects’ eligibility for the energy credit under Section 48 and bonus depreciation under Section 168. However, the Tax Court did reduce the taxpayer’s basis in the projects, and the taxpayer in the case enjoyed significant procedural advantages due to mistakes by the IRS.
In Golan v. Commissioner, T.C. Memo. 2018-76 (June 5, 2018), in late 2010 a solar contractor installed solar equipment on the roofs of three host properties and entered into power purchase agreements (“PPAs”) with the property owners. The PPAs provided that the hosts would purchase electricity generated by the solar equipment at a discount to utility rates, while the solar contractor would retain the ownership of the equipment, including the right to any tax or other financial benefits, and would service and repair the equipment.
Mr. Golan, the taxpayer, in 2011 purchased the solar equipment, subject to the PPAs, from the solar contractor for a purported purchase price of $300,000, which was the sum of a purported $90,000 down payment, a $57,750 credit for certain rebates, and a $152,250 promissory note (which the taxpayer was the obligor under but the taxpayer also provided a personal guarantee thereof). The solar projects were not connected to the grid until after the taxpayer acquired them in 2011. The IRS unsuccessfully sought to disallow the taxpayer from taking energy credit and depreciation deduction with respect to the solar equipment. Continue Reading Tax Court Sustains Energy Credit and Bonus Depreciation for Distributed Generation Solar Projects
Below are soundbites from panelists at Infocast’s Solar Power Finance & Investment Summit from March 19th to 22nd in Carlsbad, CA. It was an extremely well-attended event and the mood of the participants was generally upbeat. Many people observed that there was more capital for projects under development or to buy operating portfolios than there was such supply of projects available to meet that demand.
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.
Impact of Tax Reform on the Tax Equity Market
Impact of the Corporate Tax Rate Reduction on the Supply of Tax Equity, Yields and the Capital Stack
“This year we can do $9 million in tax credits; before we could do $15 million.” [The implication is that a 21 percent federal corporate tax rate is 40 percent less than a 35 percent corporate tax rate, so the tax appetite has declined by 40 percent.] Vice President, Industrial Bank
“The [supply side of the] tax equity market has declined by 40 percent; some tax equity investors are taking a pause.” Vice President, Regional Bank
“Our bank this year is slightly below the billion dollars of tax equity it originated last year for its own book.” Vice President, Midwestern Bank
Some “mainstream tax equity investors have taken a pause [from investing] to figure out what the 21 percent corporate tax rate means for them. It is an investors’ market, but we nervously see a sponsors’ market ahead.” Managing Director, Financial Advisory Firm
Traditionally, rates for tax equity have been a function of supply and demand, but now we are seeing real pressure on rates.” Managing Director, Money Center Bank
[It is difficult to jibe this banker’s quote regarding pressure on tax equity rates with the quotes above regarding the supply of the tax equity market being smaller due to tax reform. Possibly, tax equity investors are agreeing to share some of the yield detriment of the depreciation being less valuable and that has resulted in reduced after-tax yields.]
“Some utilities that had tax appetite no longer have tax appetite and need to raise tax equity for their projects.” Director, Money Center Bank
“We are trying to get back to the same all-in return where we were before tax reform.” [As the depreciation is less valuable at a 21 percent tax rate than it was at a 35 percent tax rate, this means either (i) contributing less for the same 99 percent allocation of the investment tax credit or (ii) contributing the same amount and requiring a distribution of a larger share of the cash.] Vice President, Midwestern Bank
“Tax reform helped us because it means tax equity contributes less to the project, so it makes our loan product more necessary.” General Manager Renewable Energy Finance, Small Business Bank
“The debt market has come in and is filling the decline in tax equity.” Executive Director, Manufacturing Corporation
“The buyouts of [tax equity investors’ post-flip interests] are more valuable because of the lower tax rate.” Partner, Big 4 Firm
“We see sponsors’ financial returns over a 35-year project life increase due to the tax rate reduction.” ” Managing Director, Structuring Advisory Firm Continue Reading Infocast’s 2018 Solar Power Finance & Investment Summit Soundbites
In a recently released private letter ruling (available here), the IRS confirmed that residential solar energy batteries are eligible for the tax credit under Section 25D of the Code (the “Residential Solar Credit”), subject to an important and unexpected caveat.
In Priv. Ltr. Rul. 2018-03-009 (Mar. 2, 2018) (the “PLR”), the taxpayers had previously installed a solar energy system on their home and claimed the Residential Solar Credit. The taxpayers were now purchasing a battery to integrate into their existing solar energy system. The battery was designed such that charging would only occur when the solar energy system was producing energy and only up to the instantaneous solar power, thereby ensuring that all energy that was used to charge the battery would come from the solar energy system. The remaining useful life of the solar energy system was expected to exceed the useful life of the battery. The taxpayers posed two questions to the IRS: (1) Is the battery a type of property that is eligible for the Residential Solar Credit and, if so, (2) will the battery remain eligible for the Residential Solar Credit even though it was installed subsequent to the year in which the solar energy system was installed. Continue Reading Residential Solar Storage is Eligible for Tax Credit, Subject to a 100% Cliff
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).
Today, the House voted 227 to 303 in favor of the tax reform bill agreed to by the conference committee. No Democrats voted for the House bill, and 12 Republicans from high tax states voted against it. The Senate is expected to vote later this evening to approve it; it is possible that the president could sign the bill as early as tomorrow.
The enacted legislation is expected to be identical to the bill approved by the conference committee. Our analysis of the conference committee’s bill’s impact on the renewable energy market is below, which is followed by a chart that summarizes the relevant provisions in each of the three bills. Continue Reading House Passes Tax Reform & the Impact of Tax Reform on the Renewable Energy Market