The renewable energy market relies on tax credits to help generate competitive returns. Under current law, the primary credits available are the production tax credit (“PTC”), which is principally used for wind, biomass, geothermal and specified other renewable energy projects, and the investment tax credit (“ITC”), which is principally used for solar projects.
The production tax credit is claimed over a ten year period and is based on the number of qualified kilowatt hours of electricity produced and sold during the tax year. The amount of the credit increases each year for inflation and currently equals 2.1 cents per kilowatt hour (1 cent per kilowatt hour for most biomass facilities). The investment tax credit for energy property equals 30% of the cost of qualified energy property (primarily solar property) placed in service during the year.
Because an investor must have taxable income to benefit from the credits, the renewable energy market has been slowed; specifically, many investors anticipate operating at a loss during 2009 and therefore do not expect to have the tax appetite required to utilize the tax credits that are necessary if renewable energy projects are to generate market returns.
The House and Senate versions of the economic stimulus bill each include various tax provisions that are designed to benefit the renewable energy market, some of which improve existing rules and others which enact new incentives. The following is a summary of the major provisions affecting businesses engaged in the renewable energy market; it does not cover all energy related tax provisions contained in the legislation. Except where noted, the provisions are included in both the Senate and House versions of the legislation. Please note that the proposed legislation has not yet been enacted into law.
Extension of PTC; ITC Election
Under current law, PTC’s are available for wind farms only if they are placed in service on or before December 31, 2009. Biomass, geothermal and most other renewable energy projects have to be placed in service on or before December 31, 2010. The stimulus bill extends the placed in service date for three years. Thus, wind farms would qualify if placed in service on or before December 31, 2012, and biomass, geothermal and most other renewable energy projects would qualify if placed in service before December 31, 2013.
The bill also includes provisions permitting taxpayers to elect to receive ITC in lieu of PTC on projects placed in service during 2009 and 2010.
Cash Grant Election
The bill would allow taxpayers to elect to receive cash grants equal to 30% of the cost of property used in solar, wind, biomass, and specified other renewable energy projects placed in service during 2009 and 2010. Taxpayers electing to receive cash grants on a project would not be entitled to ITC or PTC on the same project.
Grants generally would not have to be reported in taxable income, and the depreciable basis of the energy property would be reduced by 50% of the grant (a 15% basis reduction). Grants would be subject to recapture if the property is disposed of within five years, as well as a variety of other limitations that currently apply to ITC.
A 50% bonus depreciation could be taken on all property placed in service during 2009 (bonus depreciation would also be available for certain property placed in service during 2010). In cases where the taxpayer receives a 30% cash grant or claims ITC, bonus depreciation would equal 42.5% of equipment cost (50% of 85%), since taxpayers claiming a cash grant or ITC are required to reduce the tax basis of the relevant property by 15% (one half of the grant or credit).
The bill increases the carryback period for net operating losses that arise during 2008 or 2009 from two years to five years, with the taxpayer electing the specific number of years for the carryback. The expanded carryback period is not available for companies that receive government funds under the TARP program if the government received equity or debt that is convertible into equity in exchange for TARP funds. Under the House version of the bill, taxpayers that elect an extended carryback would be required to reduce net operating losses by 10 %.
Incentives for Research and Development; New Manufacturing Facilities
The legislation would provide an enhanced 20% R&D credit in taxable years beginning in 2009 and 2010 for research expenditures incurred in the fields of fuel cells, battery technology, renewable energy, energy conservation technology, efficient transmission and distribution of electricity, and carbon capture and sequestration.
The Senate version would also establish a new 30% investment tax credit for facilities engaged in the manufacture of advanced energy property. Credits would be available only for projects certified by the Secretary of Treasury, in consultation with the Secretary of Energy, through a competitive bidding process. Advanced energy property includes technology for the production of renewable energy, energy storage, energy conservation, efficient transmission and distribution of electricity, and carbon capture and sequestration.
Qualified Conservation Bonds; Clean Renewable Energy Bonds
The legislation would authorize an additional $1.6 billion of clean renewable energy bonds (“CREBs”) to finance facilities that generate electricity from renewable resources. CREBs were first authorized by the Energy Policy Act of 2005 and are essentially zero interest bonds issued by electric cooperatives and specified governmental entities to finance renewable energy projects (wind, biomass, geothermal, solar, municipal solid waste, small irrigation and hydropower). The bondholder receives a tax credit in lieu of interest.
The legislation also authorizes an additional of $2.4 billion of qualified energy conservation bonds (“QCEBs”) to finance state, municipal, and tribal government programs and initiatives designed to reduce greenhouse gas emissions. QCEBs were initially authorized as part of the Economic Stabilization Act of 2008 and are similar to CREBs—bondholders receive a federal tax credit and the issuer gets interest-free financing.
Effect on Transaction Structures
Under current law, most renewable energy projects that are not self-financed are structured as partnership flip transactions. Although the precise form of the transaction varies depending on the amount and placement of debt, and the amount of the developer’s contribution, the basic transaction structure involves a partnership between a tax investor and a developer which allocates the vast majority of income, loss and tax credits to the tax investor until it receives a bargained for return, and then flips, allocating the vast majority of income and loss to the developer. The developer generally receives an option to acquire 100% ownership after the flip.
The stimulus bill may favor a lease structure over a partnership flip since a lease structure permits taxpayers to separate the credit from the depreciation allowance. Specifically, in a partnership flip transaction, the credit can be allocated to the tax investor only if the tax investor is allocated depreciation deductions as well. This is generally not problematic under current law since investors that can benefit from tax credits can benefit from depreciation as well; in both cases, the investor has to have sufficient tax appetite.
By permitting an election to receive cash in lieu of credits, the stimulus bill permits an investor to benefit from the credit even if the investor does not have taxable income. Thus, it may be beneficial to separate the depreciation from the credit, allocating the depreciation to a party that has tax appetite and the credit to a party that does not have tax appetite. This is possible in a lease structure, which permits the parties to pass ITC to the lessee.
Thus, a renewable energy project can be sold to a party that has the ability to utilize depreciation, either as a result of having current income or the ability to use carry backs. The lessor could then either retain the ITC/cash grants for its own benefit, or lease the project to another entity and elect to pass on the ITC/cash grant to the lessee.
For example, a developer could sell a renewable energy project to a tax equity investor and lease it back, retaining the cash grant. This would reduce the developer’s financing costs since 30% of the purchase price would be captured in the form of the cash grant. The developer could be granted a purchase option so that it could reacquire the property at the end of the lease.
Alternatively, a developer could retain ownership of the project and lease it to a tax investor, passing on the ITC/cash grant but retaining depreciation to offset rental income. This structure permits the developer to retain ownership of the project at the end of the least term without need of exercising a purchase option.
Finally, developers could continue to transfer both the depreciation and ITC/cash grants to investors, either through use of a partnership flip transaction or through use of a sale-leaseback.
Developers will need to determine which alternative yields the package of benefits that is best from an overall financing standpoint.
Effect on Renewable Energy Financing Market
The bill will likely improve the financing market somewhat because it permits investors to monetize credits through the cash grant program, even if those investors do not have sufficient taxable income.
Monetization of depreciation benefits is more difficult, though the increased carryback period for net operating losses could be beneficial. For example, an investor who has 2009 losses can carry those losses back for five years (subject to a 10% reduction in the amount of the loss) and claim a refund of taxes previously paid. This increased carryback period could permit monetization of 2009 bonus depreciation.
The legislation does not open the market to non-corporate investors since such investors are limited in their ability to utilize losses and credits from renewable energy projects under the passive loss rules. In general, these rules prevent non-corporate taxpayers from utilizing credits and losses attributable to so-called passive activities (in general, business activities in which the taxpayer does not materially participate) to offset active business or portfolio income. Providing an exemption from the passive rules for losses and credits from renewable energy projects would potentially increase the investor pool.