New guidance on the transfer of tax credits
By Danielle Nieh, SVP, Head of Tax Liability, Hannah Tucker, AVP, Underwriting Leader and Courtney Johnson, AVP, Underwriting Leader
Following the enactment of the Inflation Reduction Act (“IRA”) in August 2022, the U.S. Department of the Treasury (the “Treasury”) and the Internal Revenue Service (the “IRS”) have released additional guidance regarding the transfer of tax credits under Code Section 6418. The guidance, released on June 14, 2023, is in the form of a notice of proposed rulemaking and public hearing (the “proposed regulations”) and temporary regulations that outline pre-filing requirements for the transfer of tax credits (the “temporary regulations”). This guidance was long-awaited as it provides detailed information on the eligibility requirements for a transfer of tax credits and more certainty around other aspects such as transfer election procedures, potential penalties imposed and filing requirements.
Eligibility requirements and guidance
As mentioned in our previous blog post, Code Section 6418 allows certain eligible tax credits, including renewable energy credits, to be sold to unrelated parties in exchange for cash. To properly transfer credits, the seller must make a transfer election on their original tax return for the tax year in which the credits are generated. A transfer election cannot be made or revised on an amended return; therefore, the seller can elect to transfer their credits from the point of generation up until their tax return is due, including any applicable extensions. The buyer is also required to include information on their tax return regarding the transfer election. The proposed regulations lay out the specific requirements to make a transfer election.
The temporary regulations provide that prior to completing a transfer election, the seller must fulfill certain pre-filing requirements. These include registering the transfer electronically with the IRS and receiving a registration number.
The proposed regulations provide guidance for several areas of uncertainty; we have highlighted a few below.
- The proposed regulations state that any taxable entity is an eligible taxpayer and may transfer all or a portion of their tax credits, provided that the portion of the credits transferred includes a proportionate share of any bonus credit amount taken.
- The IRA, in expanding renewable energy tax credits, created incremental or bonus tax credits that would apply on top of the base tax credit percentage.
- A taxpayer may receive bonus credits for meeting certain prevailing wage and apprenticeship requirements, satisfying domestic content requirements or placing a renewable energy project in service that is within an “energy community.” The proposed regulations explain that the taxpayer cannot transfer these bonus credit amounts separately from the base credit.
From the IRA, it was clear that the tax credits could only be transferred once; however, uncertainty existed around the use of brokers. Importantly, the preamble to the proposed regulations clarified that the use of brokers in aiding the transfer of credits does not create a second transfer so long as the arrangement does not transfer the tax credit ownership to the broker at any point in time.
Transfer of risk and excessive credit transfers
As the buyer is the party benefitting from the credit, the proposed regulations shift responsibility for qualification and recapture of the credits from the seller to the buyer. Qualification refers to whether the renewable energy project generating the credits is eligible and qualified to receive such credits. Recapture occurs if the renewable energy project is sold, otherwise disposed of, or removed from service within a certain time period following its operational start date. If under audit, a portion of the tax credit is disallowed or reduced, the buyer is responsible for repaying the disallowed tax credit amount.
A 20% penalty is imposed if the IRS finds that there was a transfer of tax credits greater than what was available to transfer (an “excessive credit transfer”). However, the proposed regulations clarify the 20% penalty does not apply for recapture, as this is a condition occurring only after the transfer. The 20% penalty will also not apply if the buyer can demonstrate that the excessive credit transfer resulted from reasonable cause. This is a facts-and-circumstances test in which the taxpayer must demonstrate they reasonably relied on documentation such as third-party reports, the tax credit seller’s records, and financial statements. The Treasury and the IRS expect that the buyer will perform adequate due diligence upon contemplating a tax credit purchase. Given the shift of risk to the buyer, we expect to continue to see the use of tax insurance to cover such a risk.
The comment period for the proposed regulation is open now, and all comments must be received by August 14, 2023. A public hearing on the proposed regulations is scheduled for August 23, 2023. The temporary regulations apply for transfers made in taxable years ending on or after June 21, 2023. The proposed and temporary regulations have improved certainty to all parties involved in the transfer of credits, and we expect to see an increase in transactions as a result. Tax insurance will continue to be an option for parties seeking to mitigate their risk associated with the transfer of tax credits.
Disclaimer: This material has been prepared for informational purpose only, and is not intended to provide, and should not be relied on for tax advice. You should consult your own tax advisors before engaging in any transaction.