On April 25, the U.S. Treasury released final guidance on transferability of clean energy tax credits.
Key Provisions
- To allow companies without adequate tax liability to participate in clean energy tax credits, the Inflation Reduction Act created a new provision called Transferability that allows eligible companies to sell their credits to other taxpayers;
- A seller can transfer all or part of the tax credits;
- IRA tax credits thus far are trading for .95 cents on the dollar; and
- Under the finalized rules, buyers of the credit face recapture risks.
Overview
Section 6418 of the Inflation Reduction Act (“IRA”) allows an “eligible taxpayer” to elect to transfer all or a portion of certain “eligible credits”[1] to an unrelated party. The purpose of the provision is to provide taxpayers greater flexibility to monetize energy-related credits, even if the taxpayer that earns the credit lacks sufficient tax liability to utilize that credit.
In the guidance released April 25, the Treasury Department establishes the parameters of the transferability program. Specifically, the transfer of credits is permitted for generating renewable, nuclear or other zero-emissions electricity; for capturing carbon emissions or producing clean hydrogen and clean transportation fuels (like sustainable aviation fuel); manufacturing wind, solar and storage components or processing, refining or recycling 50 types of critical minerals; for building new factories and re-equipping existing assembly lines to make or recycle products for the green economy and reduce greenhouse gas emissions at existing factories by at least 20%; and for installing electric vehicle and other clean fuel charging stations in low-income and rural areas.
Dates and Eligibility
Should a company decide to pursue transferability, the deadline to sell its tax credits is the due date for the annual tax return for that year. For example, a project owner could complete a sale of 2023 tax credits as late as September 15, 2024 if the seller is a partnership, or October 15, 2024 if the seller is a corporation or individual.
The purchase of the credit must be in cash, and the IRS will negate any tax credit sale where the buyer pays the purchase price only partly in cash. NOTE: Any transactions where the cash paid is less than the market value, the IRS may contend that the seller received something other than cash and negate the sale.
The full cash purchase price must be paid between the first day of the seller’s tax credit year and the earlier of the date the seller or buyer files its annual tax return. For example, a seller using a calendar tax year and selling 2023 tax credits must be paid the full purchase price between January 1, 2023, and when the seller or buyer files its tax return reporting the tax credit sale.
While the process for selling investment tax credits is relatively straightforward, production tax credits, which are realized over time, require buyers to pay sellers year by year. As a result, any seller who wants to sell full purchase price at the beginning would have to borrow debt against the future revenue stream from a bank or other lender.
The seller must provide the following “minimum documentation” to the buyer. It must provide proof that the project exists. This proof could come from a third party, like a county board or other government entity, a utility, or an insurer. The seller must also provide documents substantiating that the project is exempted from or has complied with the wage and apprentice requirements and that it qualifies for any bonus tax credits included in the sale. (For more detail about those requirements, see “IRS Issues Wage and Apprentice Requirements” here, “Energy Community Bonus Credit Guidance” here, and “Domestic Content Bonus Credit” here.) Finally, the seller must provide evidence of qualifying costs, sales or other activities that determine the amount of the credits.
Tax Implications of the Transaction
The seller does not have to pay federal income taxes on the sales proceeds. The proceeds are treated as tax-exempt income and the buyer cannot deduct its purchase price. Further, the difference between the sale price and the value of the credit does not count against the buyer’s taxable income. For example, a buyer who pays 0.92 cents for a dollar of tax credits, has an economic gain of 0.08 cents when it uses the tax credits to pay a tax liability to the government. The buyer does not have to report this gain as income.
Recapture Risk
Should a project fail within five years of the transaction, recapture rules within the guidance would require the purchaser of the credit to repay the Treasury Department. The seller of the credit is not liable. For the purposes of the provision, projects vest over five years. As a result, if a project fails after three years, the purchaser of the credit would still need to repay the IRS 2/5 or 40 percent of the value of the credit.
Interestingly, tax credits for capturing CO2 emissions can be recaptured (essentially, paid back) if the captured CO2 that has been sequestered leaks from underground storage within three years.
For additional information and questions, feel free to reach out to the 38 North team.
[1] The eligible credits are: Section 30C Alternative Fuel Vehicle Refueling Property Credit, Section 45 Renewable Electricity Production Credit, Section 45Q Credit for Carbon Oxide Sequestration, Section 45U Zero-Emission Nuclear Power Production Credit, Section 45V Clean Hydrogen Production Credit, Section 45X Advanced Manufacturing Production Credit, Section 45Y Clean Electricity Production Credit, Section 45Z Clean Fuel Production Credit, Section 48 Energy Credit, Section 48C Qualifying Advanced Energy Project Credit; and Section 48E Clean Electricity Investment Credit.