Questions arising on tax credit transferability in M&A deals for renewable energy projects

By Danielle Nieh, SVP, Head of Tax Liability, Hannah Tucker, AVP, Underwriting Leader and Courtney Johnson, AVP, Underwriting Leader

The Inflation Reduction Act (the “IRA”), signed into law in August of 2022, was enacted not only to slow inflation but to combat climate change and lower carbon emissions, as well. One notable change from the Act allows for the transfer of tax credits for renewable energy projects. 

Transferability: What is it? 

The Inflation Reduction Act (the “IRA”), enables certain eligible tax credits, including certain renewable energy credits, to be sold to unrelated parties for cash. This tax benefit is intended to encourage investments in the clean energy industry and enable a wider range of taxpayers the potential to access the benefits. The ability for solar and other renewable energy projects to be sold to unrelated parties for cash is commonly known as “transferability.”  

Transferability: How does it work? 

Section 6418 allows eligible taxpayers to sell certain tax credits to unrelated third parties without needing to enter into complex tax equity structures, as was previously the market norm. Transferability is available to eligible taxpayers for tax years beginning after December 31, 2022. The IRA allows only one sale of the tax credits, and a buyer cannot resell the tax credits it purchases. This limits the use of brokers acting as buyers of the tax credits. The buyer must also pay cash, and that cash consideration is nondeductible to the buyer and tax-exempt to the seller. Tax credits that are carried into one year from another year cannot be sold. The tax credits can be sold after the close of the tax year in which they are generated, but before the buyer files its tax return. 

Prior to the IRA, tax credit investments were mainly structured using a tax equity investor, a financial investor with a tax appetite to offset the investment tax credit. With transferability as an option, the market can now be open to smaller tax developers and a wider range of investors. The option of credit transferability also provides developers with more flexibility, permitting them to sell all or a portion of the credits to third parties, which in turn, can optimize the value of the project and significantly reduce exposure to risk from a project.

Transferability: Where does the uncertainty lie? 

The renewable energy industry is keen to receive guidance from the Internal Revenue Service (the “IRS”) on the new provisions contained within the IRA. As it pertains to transferability, it is unclear how the recapture rules will work under the new regime. 

Recapture occurs if a project or a portion thereof is sold, otherwise disposed of, or removed from service in the first five years of operation. If the investment tax credit (“ITC”) is recaptured due to a transfer or casualty event, the taxpayer must increase its federal income tax liability by the amount of the recaptured ITC. The question at this time is who will suffer recapture from a transfer or casualty event – the buyer or seller of the credits? The market is waiting on the Treasury and IRS to provide guidance. Congress drafted the transferability statute in a way that leaves a lot up to the Treasury, so we’d expect any Treasury regulations issued to be substantive. 

Despite the lack of guidance, transactions are still moving forward with tax liability insurance being one way companies can mitigate the potential risks.