The Inflation Reduction Act's introduction of transferable tax credits for green energy projects is revolutionizing renewable energy financing, offering a more streamlined investment process and significant tax savings — here is what CFOs need to know
The landscape of green energy financing underwent a significant transformation with the passage of the Inflation Reduction Act (IRA) in August 2022. One of the most innovative features introduced in the IRA is the transferability of tax credits for green energy projects, a provision that is reshaping how investments in renewable energy are funded and used.
Traditionally, tax credits have been a crucial incentive for developers of green energy projects like solar and wind. These credits help offset the cost of development, making projects more financially viable. Previously, to monetize these credits, developers would partner with tax equity investors, such as large banks or insurance companies, that could use the credits to reduce their own tax liabilities.
These traditional tax equity investments were generally longer-term investments (such as six or seven years) and often involved nuanced technical accounting considerations.
Expanded participation in tax credit marketplace
The IRA introduces a new innovative dimension to this system in the application of transferability of these credits. This allows developers to directly sell the tax credits to an expanded pool of potential investors, who then purchase these federal tax credits at a discount, using the credits to reduce their overall tax bill. Developers and sellers of tax credits benefit from a more streamlined transaction as compared to traditional tax equity arrangements. Depending on the seller profile and qualifying project technology, a tax credit transaction price can vary between 86 to 94 cents on the dollar.
Traditionally, tax credits have been a crucial incentive for developers of green energy projects like solar and wind, and these credits help offset the cost of development, making projects more financially viable.
On April 30, the U.S. Internal Revenue Service (IRS) issued final regulations under Section 6418 which provide detailed rules governing the tax credit transferability process. Overall, these regulations are consistent with the previously issued proposed regulations. While the transferability market already had taken off prior to the issuance of the final rules, the confirmation provides additional certainty for market participants to move forward with contemplated transactions.
Certain transferable tax credits include bonus-adders, which address specified policy objectives like satisfying prevailing wage or apprenticeship commitments, domestically sourcing project materials, or constructing projects in designated energy communities. In the case of investment tax credits, these bonus-adders can help developers access tax credits of up to 50% of eligible costs for qualifying projects.
Demonstrating net tax savings
Despite the obvious advantages, some companies have been slow to participate in transferable tax credits because of a lack of awareness. Some chief financial officers (CFOs) think it sounds too good to be true, and there is some apprehension due to the association with other tax programs that have seen abuse, such as the employee retention credit.
However, once CFOs understand the cash flow benefits and the lack of strings attached, their resistance often fades. To address any hesitancy, CFOs can work with their tax advisors to map out their companies’ tax liabilities and illustrate the benefit of transferable tax credits for the applicable tax year(s). Once these CFOs see the net cash tax savings on paper, their eyes may be opened to what can be quite an opportunity for savings.
In addition to taking advantage of transferability for the current tax year (by offsetting and reducing estimated tax payments), a three-year carryback for certain transferable credits facilitates purchasing credits to cover previous-year tax liabilities as well. However, this strategy must be weighed against the cash flow implications of funds potentially tied up in the IRS refund process.
Corporate tax professionals should consider taking the following actions to better help their CFO understand the benefits:
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- Model current prior-year tax scenarios with and without IRA clean energy tax credits
- Provide insight into the potential net tax savings through estimated tax payment, cash flow, and financial modeling that shows the benefit of purchasing tax credits
- Describe the due diligence procedures that will be undertaken to validate and confirm the tax credit eligibility and amount
- Outline the available risk mitigants to purchasers, such as the corporate guaranty and tax insurance typically provided by transferor
- Develop talking points to counter any misconceptions that investing in transferable tax credits constitutes tax avoidance or abuse
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Tax credit transferability is assisting in the energy transition by serving as a powerful planning tool for both green energy developers and corporate taxpayers. With the relevant IRA provisions set to last for the foreseeable future, transferability is expected to provide a sustained boost to the renewable energy sector, while also allowing businesses to reduce their tax burdens.
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