A new U.S. federal tax policy allows corporations to buy transferable tax credits from renewable energy developers. Here’s why that’s bound to make corporate sustainability professionals and tax accountants happy.
Offering tax credits for renewable energy projects has long been the U.S. Federal Government’s favorite way of incentivizing investment in clean energy, and the Inflation Reduction Act of 2022 (or IRA) clearly favors this approach. This unprecedented legislation offers a laundry list of tax credits that can be used by individuals, businesses, and even non-profits across the spectrum of clean energy areas from simple (such as purchasing an electric vehicle) to very complex (in-ground carbon sequestration).
However, the IRA’s significant expansion of available tax credits creates an interesting financing challenge: the world needs to transition to renewable energy at a breakneck pace, but as the energy transition accelerates, the demand for investment in clean energy projects is likely to significantly outpace capital investment supply. The expansive IRA tax credits offer immense value to investors with U.S. federal tax burden, but this form of investment in renewables is complex – and the total pool of investors interested in navigating this complexity just doesn’t have enough capital to keep pace with the growth in tax credit availability.
Fortunately, the IRA also contains a solution to this challenge, “Tax credit transferability.” Transferability allows tax credits to be sold, and not only to expert investors who were required to take an equity position in the renewable projects, but to any organization or individual with a federal tax obligation.
Let’s break it down into a simplified example.
How Renewable Energy Tax Credits Work
Let’s say a solar developer wants to construct a new solar farm costing $10,000,000. In accordance with the IRA, the developer has determined the solar farm is qualified to receive a 30% tax credit, equating to a $3,000,000 drop in corporate tax liability ($10,000,000 x 30% = $3,000,000) and increasing the developer’s net income by $3,000,000.
But when the solar farm is complete and producing renewable energy, it isn’t immediately profitable, and it certainly won’t owe $3,000,000 in taxes. Essentially, the developer has access to more tax credits than it could ever need. The leftover tax credits can’t be used efficiently—unless a large corporation like a bank, insurer, or pension fund with a large tax liability makes an equity investment in the solar farm in exchange for saving $3,000,000 on its corporate tax liability, along with other investment proceeds. This exchange is called tax equity investing.
Still, taken collectively, these large, sophisticated investors may not actually owe enough tax to justify financing all the wind and solar projects that need financing, especially in combination with many new types of tax credits made available in the IRA for all sorts of key enablers for decarbonization. This critical shortage of investment supply could mean important renewable energy projects sit unrealized.
A Fresh Opportunity: Tax Credit Transferability
By permitting transferable tax credits, the IRA makes it possible for more entities to access tax credits from wind and solar projects in a simpler manner. Companies no longer need to be sophisticated equity investors in renewable energy projects to access tax credits; they can now buy them. These purchases don’t require arcane knowledge of niche investing, so accessing tax credits is now more reasonable for more corporations. The name for this new tax equity market is tax credit “transferability,” where credits are allowed to be transferred a single time from the project to a buyer. (See the IRA website for detailed guidance.)
What This Tax Policy Means to Sustainability Leaders
So how does all of this relate to your company’s sustainability strategy? In brief, it can help build a business case for your climate goals.
Because tax credits may be purchased for a lower price than their value, your company could pay, for example, $0.90 for a tax credit instead of paying $1.00 in taxes. Using our earlier hypothetical example, a corporation could pay the solar farm developer $2,700,000 for its unused tax credits, then use the credits to pay $3,000,000 less in taxes – all while netting $300,000 to the bottom line.
Incorporating tax credit purchases into your climate strategy can make the whole package more appealing to your CFO. For example, the relatively low risk return of a tax credit purchase can help offset the financial risks of a power purchase agreement (PPA) in today’s volatile market. Call us wonks, but that’s why we are so excited about this policy!
Another benefit? As mentioned, buying tax credits helps the renewable energy industry keep growing beyond the limits of traditional tax equity dollars. Unfortunately, these purchases usually will not include renewable energy certificates (RECs) and thus will not show up in your greenhouse gas accounting or count towards a science-based emissions target. But the impact is still there—and it’s important.
The Bottom Line
While transferability allows much easier access to renewable energy tax credits, government rules allocate some risks to the credit buyer to incentivize due diligence. If tax credit purchasers are going to play an important role in financing the energy transition, it makes sense to incentivize them to invest wisely in quality projects that follow the tax credit rules. In general, the risk to tax credit buyers is quite low, but as with any investment, it’s crucial to understand the risks and protect against them.
Providing a source of funding for the decarbonization of our economy while realizing a return on the investment is a winning pitch that would stoke the interest of many financial decision-makers. Could the new tax credit transferability market play a role in your company’s climate strategy? Coho’s team has the experience to help you develop a tax credit procurement strategy, conduct procurements, perform due diligence, and defend against risk. Contact us to learn more and get started.