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Last updated on June 28th, 2023
On June 14, 2023, the IRS issued guidance around transferability mechanics and proposed regulations that provide much-needed clarity for the clean energy industry following passage of the Inflation Reduction Act (IRA) in August 2022. The goal of this post is to explain the guidance and share our insights so that companies can transact with confidence. We also outline what to expect from further regulations and guidance.
The big picture Tax credit transfers have been legally allowed since February 13, 2023, (180 days after the IRA was passed), but some of the finer details had been unclear – putting a pause on many tax credit transactions being finalized or announced.
The June 14 guidance clarifies the government's proposed new regulations and sets the stage for how transactions should play out for corporations and project developers to register and file these transactions.
Importantly, by providing buyers and sellers a clearer understanding on timing and risk allocation under tax transferability, the guidance immediately unlocks hundreds of millions of dollars in capital that had been waiting to close credit transfers, with billions more to come.
The finer print We cover the following eight key areas coming out of the June 2023 guidance:
Registration of eligible properties and their tax credits
Mechanics of tax credit transfers
No tax on buyer's discount
Form of payment
Timing for tax credit transfers
Treatment against estimated quarterly payments
Divisibility of credits to multiple buyers
Recapture risks for buyers and sellers
Below, we look at each of the eight areas, breaking down what the guidance says and providing our expert view of what it means. Additionally, there are several areas that are notably missing from guidance, for which we provide our thoughts at the end.
Let’s dig in.
Registration of eligible properties and their tax credits What the IRS guidance clarifies:
Any seller of a credit is required to register and make a subsequent election for the tax credits on a property-by-property basis. This will be through an online registration process run by the IRS, and will provide a registration number.
The registration number will be used by both the seller and buyer of credits when they elect to transfer the credit.
For credits that will be sold in subsequent tax years (e.g. production tax credits), these registrations will be required to be updated each year providing confirmation of the continued eligibility of the property.
Treasury is requesting further suggestions from industry on how it can provide grouping solutions to buyers acquiring multiple credits in a single transaction.
Treasury has also indicated that the online portal must be available by Fall 2023 to allow ample time for registrations before the 2023 tax filing season.
Basis Climate view The registration process not only provides significant confidence to buyers that the projects that qualify for the credits they are buying not only meet the registration requirements, but it also ensures that credits are not sold multiple times or in excess (important for both the government and US taxpayers). This is a clear example where technology solutions such as Basis Climate can provide sellers and buyers standardized and scalable solutions to registering and transferring credits.
No tax on buyer’s discount What the IRS guidance clarifies:
If a buyer purchases a credit at a discount (i.e., pays less than the credit amount transferred), there is no gross income and no tax due as result of this discount. The buyer nor the seller incurs taxable income in this transaction.
Basis Climate view This is good news and was uncertain to tax credit buyers prior to the guidance release. This makes tax credits more attractive to buyers, and helps financial decision makers understand the economic impact of these tax credit transactions.
Mechanics of tax credit transfers What the IRS guidance clarifies:
After the credit-qualifying property is registered, the seller and buyer must fill out a transfer election statement before including the credit in their tax filings.
In addition to the bilateral agreements made between buyer and seller (e.g. Basis Climate’s standardized tax credit Purchase and Sale Agreement), the transfer election statement is a document that describes the transfer of a tax credit from one taxpayer to another. It must be signed by both taxpayers and include information about the credit, the property that gave rise to the credit, and the relationship between the taxpayers. The transfer election statement allows the transferee taxpayer (buyer) to claim the credit.
Basis Climate view Documentation and preparation of this statement is critical to ensuring that the IRS can track credit transfers, while also giving confidence that both the seller and buyer of the tax credits have sufficiently diligenced and agreed on the quality and quantity of credits being transferred. Basis Climate supports both parties in completing the relevant documentation in a cost-effective, streamlined process.
Form of payment What the IRS guidance clarifies:
The guidance confirms that the buyer must pay the eligible seller in U.S. dollars for the credits, and that the payment is the sole consideration required for the transfer of a specified credit related to a registered property.
Basis Climate view We believe this supports regular business activity and makes transactions simpler to value and assess rather than other forms of payment or interests in projects.
Timing for tax credit transfers What the IRS guidance clarifies:
It was clear in the IRA that tax credits could be purchased from a seller after the project has completed construction (an improvement from the partnership requirements in tax equity), but the outer bounds of this timing required clarity.
The guidance confirms that the transfer election statement, along with the necessary filing, cannot be completed until either the eligible taxpayer (seller) has filed their tax return for the year in which the credit is being transferred or the transferee taxpayer (buyer) has filed their tax return for the same year.
That being said, buyers may elect to purchase for credits in advance of having pre-registration numbers for the eligible properties but until the procedural documentation and transfer election requirements mentioned above are finalized, but buyers will not be able to include these elections for their 2023 tax filings until the registration portal is available and detailed transfer election requirements are published by the government.
Basis Climate view The government has made it clear they need to provide the required registration processes and documentation in time for the 2023 filing season, and do not want to hold up transfers this year. Basis is building the guidance procedures and process into its standardized contracts between buyers and sellers.
Treatment on estimated quarterly payments What the IRS guidance clarifies:
One question we’ve received from many of our buyers is whether they can account for these credits in their quarterly estimated tax payments.
The answer is yes: “A transferee taxpayer may also take into account a specified credit portion that it has purchased, or intends to purchase, when calculating its estimated tax payments.”
Basis Climate view We believe this is a big “unlock.” While certainty on overall tax liability becomes clearer to any taxpaying corporation the later it is in their tax year, being able to start adjusting and diminishing estimated tax payments on a quarterly basis allows them significant opportunity to buy credits more frequently throughout the year, adding to the liquidity of capital for these clean energy projects.
Divisibility of credits to multiple buyers What the IRS guidance clarifies:
The IRS clarified that while bonus credits (also known as “Adders”) cannot be sold separately from a project’s main tax credits, it did confirm that entire credits could be divided from the whole of the credits, sold to multiple buyers on a vertical basis.
Basis Climate view We believe that this is the correct approach in the long term, and will drive more projects to monetize their credits through transferability for optimal economic benefit, especially for projects considering Low Income bonus credits approved through allocation, which may take time for approvals.
Recapture risk What the IRS guidance clarifies:
Broadly, recapture risk is generally transferred to the buyer. We believe most transfer agreements will require the seller to indemnify the buyer against any non-buyer-caused risk.
However, the rules do clarify that if there is an indirect (upstream) change in ownership of a project, there is no recapture on the buyer.
Basis Climate view We anticipated that recapture of the credits would go to buyers, and that seller indemnities and tax recapture insurance can protect buyers against seller organizational changes out of their control. This is a massive benefit to sellers who are concerned about indirect (upstream) ownership changes within the recapture period, and should also reduce the cost of recapture insurance.
What’s left and what's next? There are some areas that were not covered (sufficiently, or at all) in the guidance. In particular, guidance around how taxpayers can step up the basis of their credits under transferability is not clear. We are continuing to work with our external counsel and advisors to provide sellers clear guidelines on establishing equity structures that support step-up in basis tax credits. The guidance applies the passive-loss rule to buyers, which prevents individuals from using the tax credits. While these active and passive income rules (IRC Section 469) are expected to apply on these credits, given they are general business credits, the IRS has indicated they are seeking more comments in advance of providing further guidance on this matter.
Let’s get to work Basis Climate is working with a large pipeline of buyers and sellers, matching hundreds of millions of dollars of credits from clean energy projects being installed this year and next.
We are working with our buyer and seller networks to finalize in-process transactions, and include relevant registration and reporting requirements in our standardized documents and transaction framework.
The guidance provides clarity on tax transferability, and supports our mission in reducing transaction frictions and costs, ultimately deploying more clean energy infrastructure projects in the immediate future.
