The U.S. Treasury Department has recently provided its final rules on transferring clean energy tax credits. This change ushers risks and challenges that companies need to be aware and wary of when engaging in transfers.
According to the final rules, buyers who claim clean energy tax credits are taking on the risk of potentially losing these credits due to qualification deficiencies or tax credit overstatements by the seller. For investment tax credits (ITCs), buyers also risk having to repay a part or the full tax credit to the government if particular events related to the project transpire.
The Treasury refused the option of allowing tax credit sellers to split the tax credits from a specific project into higher and lower-risk segments to meet the needs of buyers with varying risk tolerances. However, companies have begun to tackle these issues by structuring deals and terms effectively. Sellers can potentially ease transactions, lessen price discounts, and improve cost efficiencies by considering structural and transactional strategies to reduce buyers’ risk.
Risks associated with clean energy tax credits can generally be divided into two groups. The first is the risk of claiming credits that the relevant project was not entitled to, either due to a failure to meet qualification requirements or overstatement of the amount. The final rules term this an “excessive transfer” and place the risk squarely on the purchaser. Additionally, the rules stipulate a 20% penalty on the purchaser unless they can show that sufficient due diligence was conducted.
The second risk, termed “recapture” liability, applies only to ITC projects. If there’s a change of ownership or the project is permanently decommissioned within a designated period (usually five years), all or a portion of the ITC must be paid back. The amount of recapture is 100% during the first year and gradually decreases annually to 0% after the recapture period. Except for an indirect change of ownership for a project owned by a partnership, the liability once again rests on the purchaser.
Given these risks, market participants should conduct detailed due diligence about the tax credit qualifications and amounts of the underlying project to avoid additional penalties. Sellers are expected to provide adequate documentation and third-party verification of critical facts. Buyers should also ensure they get strong representations regarding the project’s tax credit qualification and claimed amounts, backed by indemnification.
Finally, tax credit purchases and sales can be further safeguarded by additional protections. If material credit support isn’t viable, prospective ITC sellers may want to consider pre-sale structuring to mitigate a buyer’s recapture risk. This might involve establishing ownership of the project via a bankruptcy-remote special purpose vehicle, obtaining loss-payee casualty insurance endorsements, or agreeing on acceptable foreclosure forbearance terms with project financing parties.
For more information, read the full article on Bloomberg Tax.