Today, December 22, 2017, President Donald Trump signed into law the tax reform bill, “An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018” (H.R.1). The most notable change in this sweeping tax legislation is the reduction of the maximum corporate tax rate from 35% to 21%, however, there are other ways in which the new tax laws will impact renewable energy projects. Below is a summary of the tax law ramifications that will most widely affect renewable energy projects.
1. PTCs: There is no change to the production tax credit (PTC) pursuant to Code Section 45. This is good news for the wind industry given the original House bill attempted to codify the current IRS Guidance regarding “begin construction” and would have eliminated the inflation adjustment for PTCs related to new projects that begin construction after enactment of the bill. Removal of the inflation adjustment would have reduced the PTC for new projects from the current 2.4 cents per KWh to 1.5 cents per KWh. Also, there was concern that the House bill’s attempt to codify the IRS Guidance regarding “begin construction” might have cast some doubts on using the 5% expenditure safe harbor for both projects under construction and new projects. The Tax Reform Bill does not modify Section 48 of the Code, which also leaves in place the current IRS Guidance, allowing projects to demonstrate construction has begun by either starting physical work of a significant nature or expending at least 5% of the total costs of the project.
2. ITCs: There also is no change to the investment tax credit (ITC) pursuant to Code Section 48. The original House bill included extensions of the ITC for technologies that were not included in the last extenders bill (including fiberoptic solar, fuel cell, micro turbine, geothermal heat pump, small wind and CHP). The House bill also attempted to remove the permanent 10% ITC for solar and geothermal after 2027, and had a codification of the current IRS Guidance regarding beginning of construction. In the end, the Tax Reform Bill does not modify Section 48 of the Code.
3. 21% Corporate Tax Rate: The reduction of the maximum corporate tax rate to 21% will affect renewable energy projects that have or are contemplating tax equity investors. The lower tax rate will reduce the present value of depreciation tax benefits, but will also reduce the after-tax costs of income allocations to each partner. For example, an operating renewable energy project that has already depreciated all of its equipment based on a five-year MACRs depreciation schedule will find that that the after-tax costs to a tax equity investor for the remaining years of tax allocations will be less than at the previous 35% corporate tax rate. This will likely accelerate the flip date for many operational wind projects.
4. Corporate AMT: The Tax Reform Bill eliminates the corporate alternative minimum tax (AMT). This is an important development for the renewable energy industry given that earlier versions of the tax bill did not eliminate the corporate AMT and, as such, could have resulted in corporate AMT taxpayers claiming the PTC for only four years of the current 10-year PTC period. This indirect reduction in application of the PTC would have had a significant impact on domestic corporations intending to claim the PTC. The final Tax Reform Bill eliminates the corporate AMT.
5. 100% Bonus Depreciation: The Tax Reform Bill modifies bonus depreciation under Code Section 168(k) to allow 100% expensing for property placed in service after September 27, 2017 and before January 1, 2023, and then phases out bonus depreciation with 20% reductions each year. Property “acquired” before September 28, 2017, including under a binding written contract, will be subject to the old bonus depreciation rules, which is 50% through 2017, 40% in 2018 and 30% in 2019 with no bonus depreciation thereafter. The new “acquired” after September 27, 2017, requirement will affect renewable projects with turbine supply agreement, balance of plant agreement and other equipment supply agreements entered into before September 28, 2107, even though the project might not be placed in service until 2018 or later. These contracts should be reviewed carefully regarding their eligibility for 100% bonus depreciation, or whether the old bonus depreciation rules will continue to apply to that equipment once placed in service.
The Tax Reform Bill removed the “original use” requirement for bonus depreciation. This means that property previously placed in service will qualify for 100% bonus depreciation when acquired by another party. This could favorably impact operational projects that are on the market, since a buyer will now be able to take 100% bonus depreciation related to the project assets following the acquisition if structured properly.
6. Business Interest Expenses: Business interest expenses that were once deductible under Section 163 of the code now may be limited to 30% of the taxpayer’s earnings before interest, tax, depreciation and amortization (EBITDA) for taxable years beginning after 2017 and before 2022, and limited to 30% of a taxpayer’s earnings before interest and tax (EBIT) for taxable years beginning after 2021. The limit does not apply to regulated public utilities, certain electric cooperatives and taxpayers with average annual gross receipts for the current and prior two taxable years that do not exceed $25 million. Disallowed interest expenses can be carried forward indefinitely. Also, the business expense limitation is applied at the partnership level for businesses operated in a partnership. Any interest that cannot be deducted by the partnership because of the limit would be allocated to the partners in the same ratio as net income and loss, and could be used in future years to offset any excess income allocations. The exclusion of interest deductions will impact renewable energy projects with project debt, particularly projects with large annual revenues beginning in 2021 when the 30% limit is applied to a much smaller earnings base. Upper-tier debt may also be affected by these same limitations.
7. NOLs: The Tax Reform Bill only allows net operating losses (NOLs) to be used to offset up to 80% of taxable income, without any ability to carry back NOLs to prior tax years. Unused NOLs can be carried forward indefinitely. The 80% limit on the use of NOLs could impact sizing for some tax equity investments or even hinder an investor looking to offset taxable income for prior years, but those would need to be looked at closely to determine the true impact of reduced NOL use.
8. Partnership Technical Terminations: The Tax Reform Bill eliminates the current rules regarding partnership technical terminations under Section 708(b)(1)(B) of the code. Technical terminations occur when 50% or more of interests in both profits and capital are transferred in any rolling 12-month period. This results in the technical termination of the current partnership and the formation of a new partnership for federal tax purposes, with depreciation schedules being restarted in the new partnership. Many partnership flip structures in the renewable energy industry have prohibitions on transfers that could result in a technical termination, including upstream transfers. The removal the partnership technical termination rules will allow partners in renewable energy projects to more easily make transfers of their partnership interests, and even avoid indemnification if the partnership documents required indemnification by the transferring partner for technical terminations.
9. Section 199 Deductions: The Tax Reform Bill eliminates the deduction for income attributable to domestic production. Code Section 199 allowed for a 9% deduction from income for qualifying production activities income, including energy generation from renewable energy projects. The elimination of this deduction will impact owners of renewable energy projects since the deduction is no longer available.
10. The BEAT: The Tax Reform Bill creates a new base erosion and anti-abuse tax (BEAT). The BEAT is intended to apply to companies that significantly reduce their U.S. tax liability by making cross-border payments to affiliates. The BEAT applies if 10% of the cross-border payment amounts exceed the company’s regular U.S. tax liability. In calculating the company’s U.S. tax liability, certain credits, such as the PTC and the ITC, are taken into account, making it less likely that such a company is subject to the BEAT. The final bill, however, only allows 80% of the PTC and ITC to be excluded from the BEAT calculation, thus jeopardizing 20% of the PTC and the ITC for BEAT taxpayers. The BEAT will affect the availability of the PTC and the ITC for multinational tax equity investors by excluding 20% of the total PTC and ITC the taxpayer otherwise would have used to offset any BEAT owed.
What’s Next? In 2018 look for extenders bills to be introduced that will attempt to extend PTC and ITC provisions that expired in 2016 for geothermal, combined heat power, landfill gas, biomass, small hydro and marine technologies. Similar bills might also bring the ITC for geothermal in parity with solar by allowing a 30% ITC for projects that begin construction through 2019, 26% ITC for projects beginning construction in 2020 and 22% ITC for projects beginning construction in 2021. Extenders bills should be closely monitored in 2018 for developers and investors with biomass, landfill gas, geothermal, CHP and other qualifying projects in the pipeline.