6418 tax credit transfers provide a low risk and tax-efficient way to reduce the corporate tax rate.
Prior to the Inflation Reduction Act, tax equity evolved for over 15-years to become the gatekeeper to developers of renewable energy projects in the United States. Since wind and solar project developers could neither (1) use the tax attributes generated by the projects, nor (2) sell these credits to companies that could use them, they formed partnerships with large banks and insurance companies that enabled them to raise cash in exchange for an allocation of the tax benefits. Taxpayers participating in such structures walked a tight rope – although their primary reason to invest in renewable energy projects was to earn tax breaks, they needed to earn some cash flow out of the deal to demonstrate economic substance. Otherwise, there’s the risk the IRS could audit the investment and conclude such partnership arrangement was a sham, thereby triggering a disallowance of the tax benefits.
What flourished over these years were dizzyingly complex tax equity structures. Costs to entry were high, with seven figure transaction costs just to close an investment not uncommon.
In order to gain an advantage in the competitive environment of developing renewable energy projects, project developers hired and grew teams of project finance professionals that were capable of modeling, negotiating, and managing tax equity partnerships.
With the passage of the Inflation Reduction Act, Congress created a second path by which developers can now walk – the tax credit transfer.
Transfers are a sale of the tax credit. The buyer pays for it in cash, and the transaction is governed by a purchase agreement. Taxpayers enter into such trades because they pay for the credit at a discount.
Sellers enter into the trade for a combination of reasons: (1) they save money on transaction costs; (2) transfers provide flexibility on their power marketing plan (i.e. more merchant exposure); (3) tax equity is not available for their project; and (4) they can use the depreciation but not the credit, and so economically it’s a better deal for them.
The transfer market is only a few months old, yet shows promise to grow into a fifty-billion dollar per year market in five years. It’s an exciting time to be in the industry.
There’s been a lot of financial and commercial analysis trying to answer the question of whether tax equity will fall to the wayside.
Some say tax equity will remain relevant because of depreciation. Others say the efficiency of transfers will save enough in costs to make it competitive.
Nobody has a definitive answer to this question.
The better question is – the one that speaks to why people are so excited by transfers is – what does the customer want?
The customers are the corporations that will use the credits to reduce their tax liability, and in so doing support the transition to renewable energy. What do they prefer - tax equity or transfers? One requires a million dollars of closing costs and months if not years of education in order to understand. The other is like a coupon at the grocery store, it saves you some money on something you need to spend money on.