Energy tax reform has been the subject of three recent, and very significant, administrative and legislative proposals:
- The President’s 2015 budget, released on March 4, 2014;
- The comprehensive tax reform plan released on February 26, 2014, by Representative Dave Camp (R-Mich.), chairman of the House Ways and Means Committee; and
- The energy tax discussion draft released on December 18, 2013, by then-Senator Max Baucus (D-Mont.), then-chairman of the Senate Finance Committee.
In this legal alert, we: (1) review the most noteworthy energy tax provisions in each of those proposals; (2) discuss the current state of tax reform; and (3) address what the energy tax proposals mean for companies in the energy sector.
Energy Tax Highlights of the Obama Budget, Camp Proposal, and Baucus Discussion Draft
The Obama Budget, Camp Proposal, and Baucus Discussion Draft present three alternative federal tax futures for renewable and fossil energy, and each is described below.
On March 4, 2014, President Obama released his 2015 budget (the “Obama Budget”), which includes a comprehensive collection of spending and tax measures and annually is one of the most important policy documents of the Administration. The budget is accompanied by the Department of Treasury “Greenbook,” a description of each new revenue provision proposed by the President.
Significant energy tax proposals in the Obama Budget include:
- Production tax credit (PTC) – The PTC would be permanently extended and, starting with projects that begin construction in 2015, the PTC would become a refundable credit. A refundable PTC would dramatically alter the economics of renewable energy projects by reducing the need for “tax equity” investors with taxes to offset. The PTC would become available for electricity directly consumed by producers as well as electricity sold. Solar projects would become eligible for the PTC, likely starting in 2015.
- Investment tax credit (ITC) – The ITC would be repealed for projects placed in service after 2016. This applies for both the current 30% temporary credit and the 10% permanent credit.
- Other credits – The credit for second generation biofuels would be extended to 2020 and then gradually repealed by 2024. The 30% tax credit for investments in eligible property used in a qualifying advanced energy project, currently limited to total credits of $2.3 billion, would have additional credit authority of $2.5 billion.
- Oil and gas credits and deductions – Following the President’s agreement at a G-20 Summit to “phase out subsidies” for fossil fuels, multiple provisions would reduce or eliminate tax benefits for oil and natural gas producers. This includes repeal of: the Enhanced Oil Recovery (EOR) credit; the credit for marginal wells; expensing of intangible drilling costs; deduction for tertiary injectants; exception to passive loss limitation for working interests in oil and natural gas properties; percentage depletion for oil and natural gas wells; and domestic manufacturing deduction for oil and natural gas production.
On February 26, 2014, Representative Dave Camp (R-Mich.), chairman of the House Ways and Means Committee, released his much-awaited comprehensive tax reform plan (the “Camp Proposal”). That proposal seeks to cut marginal tax rates on individuals and corporations by dramatically reducing the number of available deductions and credits, and proposes significant other changes to the tax code that would affect taxpayers across tax brackets and industries. Many view the Camp Proposal as the most comprehensive tax reform plan released by a Member of Congress since 1986, and its breadth is hard to overstate: the legislative text is 978 pages and the section-by-section explanation is 198 pages.1
Significant energy tax proposals in the Camp Proposal include:
- Fuels credits – The credits available for alcohol fuels and alternative fuels (which expired at the end of 2011) and for biodiesel and second generation biofuels (which expired at the end of 2013) would not be extended and therefore would effectively be repealed.
- Production tax credit – The PTC would be reduced and then eliminated for generation of electricity from wind, biomass and certain other renewable resources. The PTC currently requires that construction of the project began by the end of 2013 with the credit, adjusted annually for inflation, being available for 10 years beginning in the year the project is completed. The Camp Proposal would entirely eliminate the inflation adjustment and repeal the credit for electricity produced after 2024 (including for facilities still entitled to additional years of tax credit). The proposal would also require that there be a continuous plan of construction with regard to the project (whether a PTC or ITC in lieu of PTC is claimed), regardless of when completed. It is unclear whether that requirement is intended to override IRS guidance providing that a facility the construction of which began before the end of 2013 automatically will be treated as having satisfied the continuous construction requirement if completed by the end of 2015.
- Investment tax credit – The ITC for construction of solar and other renewable energy facilities would be repealed. The repeal would affect the credit for energy facilities that are completed after 2016, including facilities that claim the ITC in lieu of PTC.
- Other renewable and alternative energy tax credits – Many of such credits also are repealed under the Camp Proposal.
- Oil and gas incentives – The Camp Proposal repeals a series of incentives, including repeal of: the Enhanced Oil Recovery (EOR) credit; the credit for marginal wells; exception to passive loss limitation for working interests in oil and natural gas properties; and percentage depletion for oil and natural gas wells.
On December 18, 2013, Senator (now Ambassador) Max Baucus (D-Mont.), then chairman of the Senate Finance Committee, released a discussion draft on energy tax reform (the “Baucus Draft”). The Baucus Draft would replace most of the more than 40 existing or recently expired energy tax incentives with two new technology-neutral tax credits for the cleaner production of electricity and transportation fuels. The value of the proposed electricity and transportation fuels credits would increase based on the cleanliness of the electricity or fuel produced. Businesses would be allowed to choose whether to receive the credit as a production tax credit, which is claimed over a period of years based on the energy produced, or an investment tax credit, which is claimed when the producing facility begins to operate and is based on the capital cost of the project.
- Clean electricity tax credit – Any facility producing electricity that is about 25% cleaner than the average for all electricity production facilities (based on EPA determinations) generally would be entitled to claim the credit.
- Clean transportation fuels tax credit – Any fuel that is about 25% cleaner than conventional gasoline (based on EPA determinations) generally would be entitled to claim the credit. The two credits would phase out once the greenhouse gas intensity of each market has declined by 25%.
- Existing renewable credits – The new tax credits would be available beginning in 2017. In the meantime, the production and investment tax credits for electric generation facilities would be available for facilities the construction of which begins before the end of 2016, and the tax credit for second generation biofuels and biodiesel would be extended through the end of 2016.
- Oil and gas incentives – The Enhanced Oil Recovery (EOR) credit and the credit for marginal wells would both be repealed.
Comprehensive Tax Reform: Where Are We Now?
The release of the Camp Proposal is the most recent legislative step in a long process that Representative Camp, along with then-Senator (now Ambassador) Baucus (D-Mont.), has engaged in to achieve tax reform. Representative Camp previously released discussion drafts on international tax, pass-throughs and financial products, and much of what was included in those drafts is reflected in the Camp Proposal. Senator Baucus had separately released discussion drafts on energy, international tax, cost recovery and accounting, and tax administration. The two Congressmen also have held dozens of hearings and travelled the country together pushing tax reform.
Although there is regular rhetoric in Washington about the need for tax reform, a clear path to comprehensive tax reform has yet to develop. The issue of whether to increase revenue through tax reform, or to have a revenue-neutral tax reform bill, has been a major partisan divide contributing to the inability to reach agreement.
In addition, shifting leadership may affect the future of tax reform. Senator Ron Wyden (D-Ore.) has succeeded to the position of chairman of the Senate Finance Committee following Senator Baucus’s swearing in as Ambassador to China on February 21, 2014. Although Senator Wyden has expressed support for tax reform, it is not clear whether tax reform is a near-term priority for him. In addition, Representative Camp is expected to step down from his position as chairman of Ways and Means at the end of the current Congress, pursuant to Republican leadership rules. Representative Camp may view his proposal as a final chance to build momentum for comprehensive tax reform.2
What Do the Energy Tax Proposals Mean for Companies in the Energy Sector?
If nothing else, the various proposals described above demonstrate just how hard comprehensive tax reform will be. They should be reviewed with the following in mind: don’t overestimate their importance, but don’t underestimate their importance.
- Don’t overestimate the importance: The conventional wisdom is that comprehensive tax reform will not happen in 2014, so any comprehensive tax reform package is highly unlikely to become law this year. In addition to fundamental differences in energy tax policy between the political parties, more broadly with respect to comprehensive tax reform there is a fundamental debate between Republicans seeking a revenue neutral bill and Democrats who have insisted that tax reform raise revenue. Moreover, tax reform’s primary advocates have lost, or soon will be losing, influence—Chairman Camp will give up the Ways and Means chair at the end of the current Congress, and Senator Baucus has retired from Congress to become the Ambassador to China.
- Don’t underestimate the importance: Although structured as a comprehensive tax reform plan, the Camp Proposal is in effect an index of hundreds of separate tax reform proposals, any of which may be introduced as part of another bill to offset some future spending program or to provide a tax cut. Although there is no expectation that the entire proposal will become law, any individual provision has the potential to be included in other legislation, including any future comprehensive tax reform proposal. It is therefore very important for taxpayers to understand which provisions of the Camp Proposal may be adverse to their interests and then to evaluate how best to deal with the possibility that such a provision may be considered in future legislation. Similarly, the Obama Budget and Baucus Draft should be considered as possible alternative proposals that possibly may find their way into future legislation, and taxpayers also should understand which provisions therein potentially may adversely impact their interests.
In light of the low likelihood of comprehensive tax reform during 2014, and the fact that a number of energy tax incentives in the renewable and alternative energy sector expired at the end of 2013, in the shorter term, it is possible that the pre-2014 renewable and alternative fuel incentives may be extended (and perhaps retroactively) in a form similar to what existed at the end of 2013. That may occur either as a stand-alone bill or, more likely, as part of a tax extenders bill to extend many energy and non-energy tax provisions that expired at the end of 2013.
In addition to considering how possible energy tax reform may impact energy companies, companies in the energy sector also should consider the currently available opportunities, including:
- Utilizing the 30% investment tax credit for solar projects, as well as accelerated depreciation and state tax benefits, to significantly reduce the overall cost to develop an on-site or utility scale solar project. Under current law, those projects must be completed by the end of 2016.
- Acquiring a wind, biomass geothermal, hydropower or other renewable energy project the construction of which began before 2014. The bar for satisfying the beginning of construction test was relatively low, and such projects are freely transferable according to guidance released by the IRS. Under that guidance, an acquirer of such a project that is under construction should be entitled to claim production or investment tax credits with respect to such project.
Energy companies in the transportation fuels sector should be aware of two recent IRS advisories that address the taxability of biodiesel mixture tax credits and, by extension, alcohol fuel mixture and alternative fuel mixture tax credits. Both of the advisories are non-precedential, but represent the current views of the IRS. Based on the first advisory, the IRS agrees that the biofuels credits under sections 6426, 6427 and 34 are non-taxable. In the second advisory (issued several months later), however, the IRS concludes that the amount of deductions for fuel excise tax must be reduced by the amount of biofuels mixture credits claimed under section 6426. Companies that claimed biofuel mixture credits and included such amounts in income or reduced their fuel excise tax deduction amounts should consider the impact of those advisories on their claimed tax positions.