Article Coursey of Amy Maloney, Authored by Casey S. August (Morgan Lewis)
Signed into law on August 16, 2022, the Inflation Reduction Act of 2022 includes a wide range of legislation addressing climate change, healthcare, prescription drug pricing, and tax matters. Among its most significant features, the act includes approximately $370 billion in energy and climate expenditures, much of which relates to changes to the Internal Revenue Code of 1986, as amended (Code), that significantly extend and expand federal income tax credit benefits for “green” energy and other technologies. The act also greatly increases the opportunities for monetizing these tax credits by introducing a limited ability to receive a direct payment from the government through refundable tax credits, as well as the novel ability to sell tax credits. These significant changes to the manner in which tax credits may be monetized have the potential to expand opportunities for investment in the diverse set of green technology industry facilities eligible for tax credits.
This article provides a brief overview of certain key aspects of the act’s green technology industry tax credit provisions and observations on potential market impact and investment opportunities.
Power Production and Energy Storage Tax Credits
The act retains the existing framework of the Code for the Section 48 investment tax credit (ITC) (a front-loaded tax credit based on eligible capital expenditures) and Section 45 production tax credit (PTC) (an annual tax credit based on production levels over a 10-year period) for certain renewable energy generation facilities, including for solar and wind facilities, but restores the credit amounts to their original maximum rates (e.g., 30% ITC) prior to stepdown and/or sunset under pre-act law. The act also now allows solar power facilities to be eligible for the PTC in addition to the ITC.
The act additionally expands the ITC to apply to new technologies, including stand-alone energy storage facilities, qualified biogas facilities, and microgrid controller equipment. Specific to energy storage, the act provides an election out of a “public utility property” limitation relating to normalization method accounting for larger energy storage facilities, which should incentivize larger regulated utilities to spearhead storage expansion as part of their infrastructure spending. The act also enacts a new PTC for existing nuclear power facilities as an incentive to delay decommissioning of the country’s existing nuclear power fleet.
Renewable energy and energy storage facilities placed in service after 2024 now become eligible for a new, technology neutral PTC and ITC that require only the “greenhouse gas emissions rate” of the facilities not be greater than zero. These new credits survive at their maximum rate for facilities that begin construction before 2034. A facility beginning construction in a later year may still be eligible for all or a stepped-down percentage of the maximum rate depending on if and when Treasury determines that the annual greenhouse gas emissions from the production of electricity in the United States have fallen by at least 75% from 2022 levels.
Carbon Capture Tax Credits
The act extends and enhances the Code Section 45Q carbon capture and sequestration tax credit. The act extends the credit eligibility date to facilities beginning construction before 2033 (from 2026) and also significantly reduces the amount-based qualified carbon oxide (generally, carbon dioxide) capture standard for a facility to be eligible for the credit. The act also increases tax credit rates for the carbon capture credit, particularly with respect to direct air capture facilities.
Clean Fuel Production Tax Credits
The act introduces a new tax credit for the production of clean hydrogen. The applicable clean hydrogen credit rate depends on the level of emissions associated with the production of hydrogen. This means that the credit rate applying to “green” hydrogen (hydrogen produced using electricity generated by a renewable energy facility) or “pink” hydrogen (hydrogen produced using electricity generated by a nuclear facility) would be greater than the rate applying to “blue” hydrogen (hydrogen produced using natural gas coupled with a carbon capture facility). The act also extends and expands tax credits for the production of qualifying clean transportation fuels, with an enhanced credit for qualifying aviation fuel.
Manufacturing Tax Credits
The act adds a new advanced manufacturing production tax credit for applicable green technology components produced in the United States or a US possession. Eligible components for this purpose include finished equipment and component parts of both onshore and offshore wind power generation facilities, solar power generation facilities, electricity inverter equipment, and energy storage equipment. Critical minerals, including certain rare earth metals, are also treated as eligible components.
The act also refreshes the Code Section 48C tax credit under which Treasury will authorize up to $10 billion of tax credits for expenditures on eligible facilities that manufacture or recycle green technology equipment and expenditures that reequip an existing industrial or manufacturing facility with equipment designed to reduce greenhouse gas emissions by at least 20%, or that reequip, expand, or establish a critical materials processing, refining, or recycling facility.
Credit Adders and Haircut
The act introduces certain standard-based incentives or “adders” and disincentives with respect to the act’s green technology industry tax credits that could significantly impact the amount of the applicable tax credit.
Critically, the tax credits for larger facilities are generally subject to an 80% haircut (although expressed in the Code as a 5-times multiplier) if a prevailing wage and apprenticeship standard is not satisfied (for example, a 30% ITC would become a 6% ITC). At a high level, the applicable standard is that all laborers employed by the project owner, any contractor or any subcontractor must be paid prevailing wages (based on the Department of Labor’s published prevailing rates for such work in a particular locality) and a sufficient percentage of such laborers must be enrolled in a registered apprenticeship program under the National Apprenticeship Act, in each case with respect to the construction, alteration, and repair of the applicable facility.
The following potential adders may separately apply with respect to renewable energy and energy storage tax credits. The act provides a 10% increase in the credit for an applicable facility if it satisfies a “domestic content” standard based on any steel, iron or manufactured product that is a component of the facility being produced in the United States under the federal “Buy America Requirements” standards. The act provides a separate (potentially additional) 10% increase in the credit for an applicable facility located in an “energy community,” which includes a designated brownfield site, an area surrounding a coal mine closed after 1999 or coal-fired electric plant retired after 2009, or a designated tract with significant tax revenues or employment related to the extraction, processing, transport, or storage of coal, oil or natural gas and with an unemployment rate at or exceeding the national average. Finally, the act provides a separate (potentially additional) 10% and possible 20% credit increase for certain smaller renewable energy facilities located in identified low-income communities or projects based on Treasury allocations of “environmental justice capacity limitation” with respect to the facility.
Monetization and Potential Impact and Opportunities
The act provides for refundable green technology industry tax credits. However, aside from limited exceptions for the carbon capture credit, the clean hydrogen PTC, and the advanced manufacturing PTC, only tax-exempt and US federal, state, local, or tribal governmental entities (including Alaska Native Corporations), the Tennessee Valley Authority and corporations operating on a cooperative basis engaged in furnishing electricity to persons in rural areas are eligible for the refundable credit.
The act also allows for the novel ability of taxable entity project owners (generally, those not eligible to claim refundable credits) to sell all or a portion of their tax credits with respect to a particular year for cash. The initial buyer of a credit may not resell the credit.
These provisions have the potential to revolutionize the way green technology industry project financing is structured and expand the investor base for green technology industry facilities.
In particular, the ability to directly sell tax credits has the potential to fundamentally alter the market for green technology industry financing, which, with respect to renewable energy, has prior to the act consisted of tax-driven structures (partnership flips, sale-leasebacks, and inverted leases) to monetize tax credits given sponsors’ (i.e., developers’) often inability to effectively utilize the tax credits themselves. As an example, under the common partnership flip structure, a “tax equity” investor must generally be a true project development joint venture “partner” (among other common law-based requirements) to effectively be compensated for capital investment with a disproportionate share of project tax credits (and depreciation). The tax credit sale provisions of the act allow investors to discard this paradigm and enjoy the type of no-risk, “pure play” tax credit purchase commercial arrangement they have long desired, although at the expense of not being able to receive the benefits of depreciation (which may not be sold along with the credits).
Although initial market indications are that there is still a desire for traditional tax equity financing transactions in which investors are beneficial equity owners of the underlying facility (and receive associated return from the operations of the facility and from disproportionate allocations of both tax credits and depreciation from the facility), the new ability to sell tax credits has the potential to expand the market of investors and for the monetization of the credits. For one, the ability to sell tax credits may have appeal, and expand financing opportunities, for smaller scale developers and projects for which the significantly increased complexity and cost of implementing a traditional tax equity investment structure is less economically viable. We also expect that the ability to sell tax credits will be critical for the development and financing of emerging green technologies, nuclear power and eligible manufacturing where tax equity investment have not to this point been deployed due to the perceived economic or legal risk associated with owning an equity ownership interest in the applicable facility (as compared to simply purchasing the tax credits). This monetization flexibility provided by the ability to sell credits may also expand the potential investor base for green energy infrastructure and technology projects, including for private investment funds with a broad climate strategy.
To-be-developed market pricing as among investors, lenders, and tax credit buyers will be critical in determining whether a net tax credit sale option results in a lower cost of capital for project sponsors versus conventional tax equity structures. Market practice will no doubt take time to develop around the documentation and structures for these pure play tax credit purchases, and there remain numerous technical questions that will need to be addressed by Treasury and the IRS in implementing regulations and/or guidance for these transactions in order for a robust credit marketplace to develop.