Originally published by Charles Sartain.
Author Joshua D. Smeltzer*
The recently passed Consolidated Appropriations Act, providing additional COVID pandemic relief, also includes important extensions for renewable energy tax credits. These extensions represent a significant tax benefit for renewable energy companies and their potential investors. However, if not done correctly taxpayers can lose the tax benefit and potentially face tax penalties. Here’s what you should know about the potential tax benefits and what to consider when claiming the credits.
The Investment Tax Credit
The Investment Tax Credit (ITC) under Internal Revenue Code Section 48 was extended by two years. This tax credit is popular for solar energy projects as well as other technologies (e.g. fuel cells, microturbines, small wind energy.) In general, solar projects beginning construction in years 2020 through 2022 are eligible for a 26% ITC, 22% ITC in year 2023, and 10% after 2023. The ITC is similar for other technologies except that it drops to 0% if construction begins after 2023, or if the project is placed in service after 2025.
The Production Tax Credit
The production tax credit (PTC) under Section 45 was also extended for one year. This tax credit is primarily used for wind projects and they can now begin construction in either 2020 or 2021 and be eligible for a 60% PTC. However, the one year extension also applies to other PTC-eligible technologies (i.e. biomass, geothermal, landfill gas, trash facilities, qualified hydropower and marine and hydrokinetic renewable energy facilities). If construction begins after 2021 then there is no eligibility for any PTC. However, a new tax benefit was also added by the new law in the form of a standalone ITC for offshore wind. These are facilities located in the inland navigable or coastal waters of the United States. Offshore wind projects are eligible for a 30% ITC for projects beginning construction before 2026 without any apparent phase down provisions.
“Legislative grace”
Tax credits are considered, by the IRS and the courts, as a matter of “legislative grace” and the burden is on a taxpayer to prove entitlement. As such, renewable energy companies and their investors should be careful when incorporating these benefits in their agreements. The IRS and, if necessary, the courts have several tools available to them to recharacterize a transaction and remove claimed tax benefits if they feel that the transaction isn’t what it purports to be. Questions usually occur if the actions or agreements involved fail to show a genuine business venture with motivations beyond tax avoidance. The agreements and actions of the parties must document a clear business purpose outside of the tax benefits and show that all parties have a meaningful upside and downside potential outside of any tax benefit.
Indemnification – yes or no?
An investor may desire, and a company may be willing to provide, certain guarantees or indemnifications that could prove problematic if the tax credits are later challenged by the IRS. For example, direct or indirect guarantees of the investor being able to claim the credit, cash equivalents of the credits, guaranteed repayment of capital contributions because the credit can’t be claimed, or guarantees of repayment or indemnification if the credit is challenged by the IRS might cause problems. Therefore, the terms of the agreement must be evaluated carefully for provisions that could raise questions about the parties having a real stake in the transaction. Despite risks, if done correctly, these tax credits provide a great incentive for investors to direct money into the renewable energy sector that companies can use to help fund projects.
*Joshua is a talented addition to Gray Reed’s tax department.
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