Group Suggests Broad Range of Changes to Transfer Credit Regs
DATED AUG. 14, 2023
August 14, 2023
United States Department of Treasury
Internal Revenue Service
P.O. Box 7604, Ben Franklin Station
Washington DC 20044
The American Clean Power Association (“ACP”) appreciates the thoroughness of the proposed regulations on tax credit transfers and appreciates the opportunity to provide additional comments in advance of issuance of final regulations.
Confirm that transferred credits can be carried forward
Treas. Prop reg sec 1.6418-5(g) has the title “Carryback and carryforward,” but provides that a transferee taxpayer may apply the rules of Section 39(a)(4), which provides a 3-year carryback period for unused current year business credits. Thus, even though the title refers to carryforwards, the proposed regulation cites only the rule for carrybacks. The final regulations should clarify that a transferee taxpayer can apply the rules in Sections 39(a)(1), (a)(2) and (a)(4), so that there is no ambiguity as to whether a transferee can carry forward transferred credits. This clarification would be consistent with the general rules of the proposed regulations applicable to the use of credits by the transferee.
Clarify the treatment of transferred credits for estimated tax purposes
Treas. prop reg. sec.1.6418-2(f) provides:
In the case of any specified credit portion transferred to a transferee taxpayer pursuant to a transfer election under this section, the transferee taxpayer takes the specified credit portion into account in the transferee taxpayer's first taxable year ending with or ending after the taxable year of the eligible taxpayer with respect to which the eligible credit was determined.
This rule does not indicate how the transferee should take these credits into account for estimated tax purposes. The preamble to the proposed regulations provides:
A transferee taxpayer may also take into account a specified credit portion that it has purchased, or intends to purchase, when calculating its estimated tax payments, though the transferee taxpayer remains liable for any additions to tax in accordance with sections 6654 and 6655 to the extent the transferee taxpayer has an underpayment of estimated tax.
This rule is helpful in that it acknowledges that transferred credits are taken into account for estimated tax purposes. However, it does not indicate how the transferee should take them into account, particularly to which quarter of the taxable year the transferred credit should be assigned. Providing clarification on the mechanics of the treatment of transferred credits for estimated tax purposes is needed because such treatment can significantly affect the value of the transferred credits. Tax credits that are taken into account for estimated tax purposes in the early part of the transferee's taxable year are more valuable than credits that are taken into account later. Following are some suggestions for the estimated tax treatment of transferred credits.
We recommend a “step in the shoes” approach for the estimated tax treatment of transferred credits, which is consistent with the theme in the proposed regulations to treat the transferee as the transferor with respect to the purchased credit for all tax purposes. Under such a rule, whatever date the credit is determined by the transferor similarly would be taken into account by the transferee. Such a rule would require some reporting coordination between the transferor and transferee, but not necessarily to the IRS. The pre-filing registration, requiring transferors to provide the placed-in-service date of eligible credit property, should make such a rule administratively practical. “Step in the shoes” treatment is suggested by preamble language cited above which indicates that transferees can take transferred credits that “it intends to purchase” for estimated tax purposes.
Example 1. — Calendar-year Transferor A placed an energy property that qualifies for an ITC in service on March 15, 2024. Transferor A enters into an agreement to transfer the ITC to calendar-year Transferee B on November 15, 2024. Under section 6418(d) and Treas. prop. reg. sec. 1.6418-2(f), a transferee takes the specified credit into account in the transferee's first taxable year ending with or ending after the taxable year of the transferor taxpayer with respect to which the eligible credit was determined. In this example, Transferee B would take the ITC into account for its taxable year ending December 31, 2024. For estimated tax purposes, Transferee B is treated as acquiring the ITC on March 15, 2024.
An adjustment would be required when the taxable year ends of the transferor and transferee do not coincide. If a transferee acquires a tax credit that is determined on a date that is prior to the taxable year that the transferee is required to take the transferred credit into account, such credit would be treated as acquired on the first day of such year.
Example 2. — Calendar-year Transferor A placed an energy property that qualifies for an ITC in service on March 15, 2024. The Transferor A transfers the ITC to Transferee B that has a June 30th year-end. Under section 6418(d) and Treas. prop reg. sec.1.6418-2(f), a transferee takes the specified credit into account in the transferee's first taxable year ending with or ending after the taxable year of the transferor taxpayer with respect to which the eligible credit was determined. In this example, Transferee B would take the ITC into account for its taxable year ending June 30, 2025, even though the credit was determined in Transferee B's taxable year ending June 30, 2024. For estimated tax purposes, Transferee B is treated as acquiring the ITC on July 1, 2024, the first day of its fiscal year ending June 30, 2025.
Alternatively, where a fiscal year taxpayer sells credits to a calendar year taxpayer, a transferee should be able to take into account purchased tax credits as early as the placed in service date.
Example 3 — March 31 fiscal year-end taxpayer, Transferor A, sells tax credits to a calendar year-end taxpayer, Transferee B. On April 1, 2023, Transferor A places a project into service and would be entitled to claim the ITC. Transferee B can purchase and reflect the credit in the quarterly estimated tax payment date that includes April 1, 2023.
It should be relatively simple for a transferor to determine the exact date that ITC property is placed in service. A transferor should also be able to determine the dates or periods that PTCs are earned. Final regulations should provide that transferees should be able to rely on representations made by transferors regarding the dates that specified credits were determined for estimated tax purposes.
Allow grouping of related credit properties and facilities
Prop. Treas. reg. sec. 1.6418-2(b) generally would provide that an eligible taxpayer is required to make a transfer election to transfer a specified credit portion on the basis of a single eligible credit property.
In requiring the election to be made on the basis of a single eligible credit property, the Treasury Department and the IRS request comments on two issues. First, whether more specific guidance with respect to any eligible credit property is needed to allow eligible taxpayers to make the election as required. If such guidance is needed, suggestions for further defining the relevant eligible credit property are requested. Second, whether to adopt a grouping rule that allows taxpayers to make an election with respect to certain groups of eligible credit properties.
To avoid confusion, Treasury and IRS should use the same concept of unit of property for section 6418 as it does for the various specified credit provisions (i.e., energy property or energy project for purposes of section 48 and qualified facility for purposes of section 45). We understand that Treasury is working on guidance to define qualified energy property for purposes of section 48, as amended by the IRA. We encourage Treasury to publish this guidance as soon as possible and to develop similar definitions for the new credits provided by the IRA (e.g., section 45V).
Final regulations should also allow the grouping of properties on an elective basis. We appreciate the flexibility of the proposed regulations in allowing tax credits to be transferred on a single eligible credit property basis. However, significant compliance burdens come with such flexibility as taxpayers would be required to identify, register, report and track each property. Some taxpayers may decide that such flexibility is not worth the additional compliance costs (particularly if they are transferring tax credits attributable to related properties together anyway) and would prefer grouping in some instances. In some cases, it might not be possible to track production from individual wind turbines. Generally, commissioning of a turbine's SCADA system must be complete for a taxpayer to track power generated from such turbine. Often, SCADA commissioning occurs much later than turbine power commissioning. Once turbines are power commissioned, they are generally released for commercial power production and begin to deliver power to the grid. The project is compensated for the power. However, it may be difficult to identify the specified credit portion on a turbine-by-turbine basis during this initial start-up period because the taxpayer would not be able to determine which turbine produced the power until the SCADA system is commissioned. Similarly, if a turbine's SCADA system is down or inoperable, there is no way to determine which power production is attributable to the particular turbine. Treating the turbines as a single project, which is how most transfers would be expected to take place as a commercial matter, would avoid requiring the taxpayer to come up with an allocation methodology in the absence of direct data at the turbine level sufficient to determine the power produced by a single turbine.
As suggested by Treasury's request for comments, requiring the election to be made on the basis of a single eligible credit property is inconsistent with how most transactions will be structured and puts too much pressure on the definition and identification of a single property. A grouping rule eliminates the uncertainty should a transferor mistakenly combine credits from more than one property on the reasonable belief that they are a single property. Because transferors may sell any portion of an eligible credit, a grouping rule would not frustrate the purposes of the proposed regulations and would make compliance easier from the taxpayer's perspective.
Final regulations should allow grouping based on precedents established in other administrative guidance. Section 4.04(2) of Notice 2013-29 allows taxpayers to elect to treat related assets as a single facility for purposes of the start of construction rules applicable to sections 45 and 48. The Notice provides a noncomprehensive list of factors to determine whether a group of assets should be treated as a single facility. These rules are a decade old and are familiar to taxpayers and the IRS. Modifications may be necessary to accommodate the new credits provided by the IRA (e.g., what are related assets with respect to a hydrogen facility).
If, for some reason, Treasury and IRS prefer to allow grouping based on a single factor, we would recommend that the identified group for electricity generating assets be based a common grid interconnection point. This will allow much simpler record keeping (and thus audit efficiency) where output is subject to aggregated reductions like collection system and interconnection losses, curtailment, or outage without the need for hour-by-hour measurements of the allocation of such aggregated reductions.
This precedent is consistent with the election provided in the proposed regulations for property with respect to which the section 48 investment tax credit is claimed. Specifically, Prop. Treas. reg. sec. 1.6418-1(d)(9)(ii) gives an eligible taxpayer the option to elect to treat the energy project (defined in section 48(a)(9)(A)(ii)) as a project consisting of one or more energy properties that are part of a single project) as the eligible credit property with respect to which the pre-filing registration and transfer elections may be made. We recommend expanding this election to all eligible credits.
Allow “bonus” credits to be transferred separately
Prop. Treas. reg. sec.1.6418-1(c) would provide that the entire amount of any eligible credit is separately determined with respect to each single eligible credit property of the eligible taxpayer and includes any bonus credit amounts determined with respect to that single eligible credit property.
We request that Treasury reconsider this rule. Allowing the separate transfer of the bonus portions of specified tax credits1 will make the transfer credit market more efficient, encourage transferors to undertake the activities to earn the bonus amounts, and ease the administrative burdens of the IRS.2
To be eligible to claim any of the bonus credits, a taxpayer must demonstrate that it qualifies for the underlying tax credit and the additional requirements for the bonuses. These additional requirements are new, can be substantial and, despite the various IRS Notices and proposed regulations issued to date, involve a great deal of uncertainty. This uncertainty is amplified for potential transferees who do not have direct insight into the transferors' facts that give rise to the bonuses. Thus, the bonus credits involve additional risk of disallowance relative to the base credits. Some potential transferees may be less comfortable accepting this risk than others and may not consider acquiring tax credits from transferors if they are required to also accept the bonus. Other potential transferees may be more comfortable accepting this risk. Still others may prefer only the bonuses because they support the underlying policy goals of the bonuses. Congress' intent in providing transferability is to expand the pool of tax credit investors beyond the traditional tax equity market. Not allowing bonus credits to be transferred separately may have the effect of limiting the market of potential transferees and may cause some projects to forgo claiming the bonus credits (e.g., because of the uncertainty with respect to the domestic content guidance).
If tax credits with bonuses attached are viewed less favorably than tax credits without the bonus risks in the transfer market, some clean energy developers may decide that qualifying for the bonus credits may not be worth the additional costs, increased administrative compliance, and risk. Such a result would seem contrary to Congressional intent in providing the bonuses.
Allowing bonus credits to be transferred separately from the base credit should facilitate standardization for the “pricing” of credit transfers. The market will determine the appropriate discount for a tax credit without bonuses. This price can also be applied to a tax credit with bonuses only if the base credit can be transferred separately from the bonus. Otherwise, the market will need to determine separate prices for each combination of base credit and potential bonuses, leading to potential inefficiencies.
Allowing bonus credits to be transferred separately from the base credit should not increase the administrative burden to taxpayers or the IRS or give rise to potential abuse given the already substantial registration and reporting requirements of the proposed regulations. Taxpayers already are required to identify and report information with respect to projects that give rise to base credits, applicable bonus credits, and transferees. It does not add administrative complexity to require taxpayers simply to further identify to whom the various components of the credits were transferred.
Allowing bonus credits to be transferred separately from the base credit should ease the administration of the transfer system by the IRS. Consider the following example: A transferor develops an energy project with a basis of $100 million that it believes qualifies for the domestic content bonus and its 10-percentage point increase. Thus, the transferor believes its project qualifies for $40 million of ITC ($30 million base credit plus $10 million bonus). Assume the credit is transferred equally to four transferees ($10 million each). Further assume that IRS subsequently determines that project did not qualify for the domestic content bonus and disallows $10 million of credit. Under the proposed regulations, the IRS must trace the excessive credit transfer adjustment through each of the four transferees and separately determine if each transferee had reasonable cause to avoid the 20 percent addition to tax.3 If the transferor was allowed to separately transfer the bonus credit to only one of the four transferees, the IRS could concentrate its audit efforts on that one transferee.
Provide more flexibility to cash payment rule to allow pre-sales of credits
Section 6418(b)(1) and Treas. prop. reg. secs.1.6418-2(a)(4)(ii) and 1.6418-2(e)(1) require that any amounts paid by a transferee taxpayer in connection with the transfer of a specified credit be paid in cash. The proposed regulations provide that a payment does not violate the paid in cash requirement if the cash payment is made within the period beginning on the first day of the eligible taxpayer's taxable year during which a specified credit portion is determined and ending on the due date for completing a transfer election statement (the “timing rule”).4 The proposed regulations also address an issue raised by commentators regarding advanced commitments and provide that a contractual commitment to purchase eligible credits in advance of the date a specified credit portion is transferred satisfies the paid in cash requirement, so long as all cash payments satisfy the timing rule.
Prior to the enactment of section 6418, clean energy project developers would enter into tax equity transactions with other taxpayers to allocate tax benefits to investors that could use the credits. Treasury and IRS guidance generally requires that the tax equity investor make a significant upfront payment and does not allow full “pay as it goes” structures with respect to the tax benefits. In other words, the tax equity investors could not “pay” for the tax benefits as they were created, but rather had to make a certain amount of upfront, unconditional capital contributions to the project.5 Clean energy project developers preferred such commitments because it provided financial certainty with respect to tax benefits, like PTCs, that would be realized over time. Upfront cash payments from tax equity investors allowed developers to pay down the more costly construction indebtedness of the energy project.
The timing rule of the proposed regulations significantly changes the landscape with respect to tax credit transfers. Under the proposed regulations, “pay-as-you-go” is generally required and substantial prepayments are not allowed, which is the inverse of the requirements for a tax equity transaction where upfront payments are required and fully “pay as you go” is not allowed. The proposed regulations do allow contractual commitments to acquire transferred credits, but only if the timing rule (pay as you go) is met.
Final regulations should consider expanding the timing rule. As indicated above, prepayments for future tax credits are useful financial tools for developers. Nothing in section 6418 indicates when consideration for transferred tax credits must be received; only that the consideration be cash. Allowing prepayments will standardize treatment for PTCs and ITCs.
In addition, whether or not Treasury modifies the timing rule, the final regulations should clarify the scope and treatment of the contractual commitments envisioned in the proposed regulations. Specifically, whether a contractual commitment is simply a naked promise to acquire future credits and a future promise to pay for such credits, or whether the commitment can involve other items such as a deposit or other consideration. Final regulations should clarify what features of a contractual commitment violate the timing rule.
Specifically, the final regulations should recognize that a sale of tax credits may be made under a single transfer agreement with one or more transferee taxpayers that covers multiple taxable years and including the entire 10- or 12-year credit period under sections 45, 45Y, 45V, or 45Q. This is critical in the case of the PTCs and other credits that are recognized over a 10- or 12-year credit period. The final regulations should confirm that the transferee taxpayer(s) may pay for any such transferred credits over the credit period on an upfront payment basis combined with annual or periodic “pay-as-you-go” payments in order to address any variability in production and applicable credits over the term of the transfer agreement. The filings for any tax year would need to reconcile the advance cash payment with the tax credits generated in a subsequent year associated with such payment and any additional cash payment with tax credits in excess of the prepaid credit amount. The final regulations should consider adding examples, similar to those below, to confirm the structure and to clarify how those rules work under the transfer election provisions:
Example 1 — Transferor A owns a wind farm that generates PTCs over a 10-year credit period from the placed-in-service date. Transferor A enters into a forward sales contract with Transferee B under which Transferee B agrees to pay Transferor A a lump-sum cash payment when the wind farm is placed in service based on a P95 level of expected PTCs for the 10-year credit period (i.e., a 95 percent probability that the wind farm will generate at least the expected level of PTCs over that period). After the wind farm produces the designated level of PTCs, Transferee B will then make ongoing periodic payments for any additional PTCs over the designated level of production for the remainder of the credit period. Assuming Transferor A and Transferee B file all appropriate and required documentation with the IRS on an annual basis, the forward sale/transfer of the tax credits accompanied with future periodic payments will comply with the “paid in cash” requirement and will be respected for tax purposes.
The above example is illustrative of the general principles for transferability as applied to the commonly used partnership flip structure. The final regulations should provide flexibility for the transfer of tax credits under a single transfer agreement that covers multiple taxable years as suited to the transaction structure.
The final regulations should also confirm that in a tax equity partnership, a transfer of PTCs does not result in a contingent contribution by an investor partner where the sponsor partner receives the cash consideration from the transfer and the investor partner receives an increase in its capital account from the allocation of the tax-exempt income.
Proposed modifications to the registration and information requirements
The proposed regulations require substantial registration, documentation, and reporting requirements to initiate and complete tax credit transfers under section 6418. Similar requirements are required for the direct pay provisions under section 6417.
The opportunity for fraud is not apparent in the case of transferability. Both the transferor and the transferee will be in the Federal tax system. The transferee will not be acquiring tax credits unless it otherwise has a tax liability. Any disallowance or reduction of a transferred credit falls on the transferee, not the government. Thus, the transferee has the economic burden of ascertaining that the transferor is legitimate and creditworthy and has satisfied the requirements for and accurately determined the amount of the transferred tax credits.
Section 6418 generally does not impose any substantially greater risks for the government than does a tax equity transaction. Treasury does not require the substantial registration, documentation, and reporting requirements for tax equity transactions that it does under the section 6418 proposed regulations. The due diligence to be undertaken by transferees is no different than the due diligence currently performed by tax equity investors in clean energy projects. This due diligence review provides an extra layer of review and should give Treasury comfort that any potential fraud concerns or defects in qualification will be discovered by potential transferees. There is no record of industry-wide abuse in the case of tax equity transactions involving clean energy tax benefits, and tax equity investors typically only transact on “will” or “should”-level opinions. Similarly, tax credit purchasers currently are requiring “will” or “should”-level opinions before agreeing to purchase tax credits. We expect similar market scrutiny and safeguards as the transfer system evolves.
The most likely fraud concerns in the transferability system are:
(1) a purported transfer from a project that does not exist or qualify,
(2) a transferor that transfers the same credit to more than one transferee, and
(3) a transferee that subsequently transfers the credit.7
As discussed further, it is not clear that the registration and documentation requirements address these concerns. The first risk is mitigated and generally eliminated by the transferee's due diligence. Further, the information filed with the purported transferor's tax return should provide enough information as to whether a qualified credit was properly generated and determined. The next two risks involve transfers. They can only be assessed with an examination of the transfer election. Nothing in the registration process deals with these risks.
Before a taxpayer can elect to transfer a tax credit, it must apply for and receive a registration number. Prop. Treas. reg. sec. 1.6418-4 requires a transferor to provide at least8 fifteen pieces of information with respect to each9 piece of qualified property that it intends to be subject to the transfer election when it registers for the transfer program. Prop. Treas. reg. secs. 1.6418-2(b)(3) and (5) also require the transferor to include information on the tax credit forms and the transfer statement included with its tax return. This information largely is duplicative of the information required to be included in the transferor's tax return under prop. Treas. reg. sec. 1.6418-4.
Much of the information required under the section 6418 proposed regulations is information that transferors possess and would normally provide to tax equity providers, potential transferees, and their representatives (although not necessarily in one “data dump” as required by the registration process). It is also information that a transferor would otherwise retain for audit purposes. Thus, the type and amount of information required under the proposed regulations is not a direct concern. Rather, as discussed in detail below, we are more concerned with the government's need and ability to process this information in a timely fashion. In addition to providing the discussion below, we would be happy to meet with the appropriate Treasury and IRS staff and consider ways to streamline the registration process in ways that address the government's concerns.
As discussed above, it is unclear how the registration requirements in the proposed regulations address any of the government's concerns. Both the transferor and the transferee are in the tax system and will be subject to audit. Prop. Treas. reg. sec. 1.6418-4 requires a potential transferor to file such information with respect to each potential piece of property in the registration process. The amount of information required with each registration will be substantial. We are concerned that these filings will overwhelm the registration system and delay the release of registration numbers. Delay will be exacerbated if the IRS intends to pre-audit or pre-certify each filing.
Any information that the IRS obtains in the registration process will be preliminary and may relate to tax credits that are never transferred. The IRS will receive information with respect to actually transferred tax credits in just a few months anyway with the filing of the transferor's tax return. Any information that the IRS needs to conduct a preliminary examination will be available at that time. As the tax credits may never be transferred, review of the preliminary materials is unnecessary and could create confusion if and when a transaction actually occurs and is audited. If the IRS needs to centralize such information, it could require a separate on-line filing when that tax credit transfer transaction is completed or when the tax return is filed; not upon registration.
Ideally, the registration of transferors should be no more burdensome than applying for a taxpayer identification number. The registration number should be provided just as automatically. Consideration should be given to providing exemptions or stream-line processes for those transferors that do not present administrative concerns (discussed below).
If the IRS wishes to establish or needs a registry, it should only request the identity of the potential transferors. Requiring the identification of each potential qualified property is not necessary. The identification of the transferor allows the IRS to determine if the filer is a bona fide clean energy project developer. Factors to consider could include if the filer is a publicly traded company or SEC filer; is creditworthy; files reports with other government agencies such as DOE, EIA, FERC, etc.; has a track record of claiming qualified tax credits; or is otherwise known by the Departments of Treasury or Energy as a clean energy developer. If the filer is known to the government, the IRS should have confidence that its credit determinations and the information contained in its tax return filing are valid. If the filer is unknown to the government, more information could be required. These distinctions will allow the IRS to concentrate its analysis of registration information on those filings that are likely to raise the greatest concerns.
As discussed above, clean energy project developers are willing and able to provide the information required by the proposed regulations to the IRS. Rather, the concern is that the IRS cannot process the information and provide registration numbers in a timely fashion to potential transferors. Time is of the essence because:
Transfer transactions are time-sensitive, with pricing sensitive to timing of benefits realized by transferees.
Transfers are often executed on or near estimated tax payment dates, with the expectation that the transferees can immediately monetize those credits by reducing their estimated tax payments.10
Some developers may not realize until late in the year (or even after year-end) that their current year credits exceed their capacity to use them. They will have a short window to transfer their tax credits. Registration delays will frustrate their ability to transfer excess credits.
Developers generally need the cash from transfer transactions to retire construction indebtedness, finance new development, etc.
The transferability provision applies to 2023 transactions. The transfer window for the current year is already short.
Provide ability to cure registration and election defects
The proposed regulations provide that an election to transfer a specified credit must be made on an original return and may not be made or revised on an amended return or by filing a request for an administrative adjustment under section 6227. Further, the proposed regulations also provide that section 301.9100 relief is not available for a late transfer election.
As described above, the amount of information required to obtain a registration number and file a transfer election is substantial. There are bound to be omissions and misstatements. The final regulations should clarify that a taxpayer will have the ability to cure these errors on an amended return or by an administrative adjustment. Further, section 301.9100 relief should be available in situations where the parties acted in good faith with respect to a transfer election.
Provide additional exceptions to assessing recapture liability on the transferee when recapture is the result of a lender foreclosure or sale of a business
Lender Foreclosure Exception
The proposed regulations include a rule that the recapture amount is calculated and taken into account by the transferee taxpayer. However, the proposed regulations provide an exception in the case of a partner or S corporation shareholder disposing of an interest in a transferor partnership or S corporation. A partner or S corporation shareholder that has disposed of an interest in a transferor partnership or transferor S corporation is subject to the rules relating to such disposition under Treasury regulations section 1.47-6(a)(2) or section 1.47-4(a)(2), respectively. Those rules provide that if a partner's (or S corporation shareholder's) interest in the general profits of a partnership (or S corporation) is reduced as a result of certain events during the recapture period by a certain percentage of the partner's (or shareholder's) interest in general profits for the taxable year of the partnership (or S corporation) in which the investment credit property is placed in service, recapture can occur to such partner (or shareholder). The preamble to the proposed regulations provides:
The recapture events described in §§1.47-4(a)(2) and 1.47-6(a)(2) are applicable with respect to the specific shareholder or partner to which the recapture event occurs and not with respect to the transferor S corporation or transferor partnership. As a result, such recapture events should not result in recapture of a transferred eligible investment tax credit to a transferee taxpayer under section 6418(g)(3)(B). Instead, the recapture tax liability resulting from the reduction of an S corporation shareholder's interest or a partner's interest in general profits should continue to result in recapture to the applicable disposing shareholder or partner. The proposed regulations would clarify that “indirect” dispositions under §§1.47-4(a)(2) and 1.47-6(a)(2) do not result in recapture tax liability to a transferee taxpayer under section 6418. Instead, these rules continue to apply to a disposing partner or shareholder in a transferor partnership or transferor S corporation, respectively.
While the exception is helpful, it does not go far enough to provide the market with the framework necessary for structuring tax credit sales from debt-financed ITC projects. Assessing recapture liability on the transferee in certain instances is one of the greatest impediments opening to the transferability marketplace. Transferability was intended to make it easier to finance smaller projects. Assessing recapture liability on the buyer has the opposite effect. While Treasury is correct that recapture can be dealt with contractually between buyer and seller, leaving it to a contractual issue severely disadvantages sellers with weaker balance sheets and weaker credit. Exactly the smaller developers that transferability was intended to encourage are finding they cannot sell tax credits from debt-financed ITC projects.
Developers without strong balance sheets generally have to bridge the proceeds of transferability with debt. The developer borrows money from a bank to develop and construct the project and pays back the loan with the proceeds of the tax credit sale. Generally, a developer will have multiple tranches of loans to finance the construction of the project, so a portion of the development/construction loan will not be paid with transferability proceeds and will covert to term debt. Lenders takes a security interest in the project as collateral to secure such term loans. This puts ITC projects at a severe disadvantage. Under the current rules, if a lender forecloses during the recapture period, a tax credit transferee would suffer the recapture. Potential transferees are refusing to purchase tax credits from projects where the lender has a security interest in the project during the recapture period. Insurance markets are also declining coverage for recapture when the lender has a security interest during the recapture period. This is not an issue for PTC projects because if a lender forecloses, the lender can step-in-the-shoes of the transferor and continue to transfer tax credits to the transferee.
Final regulations should consider an exception for recapture resulting from a lender foreclosure in order to ensure that ITC projects, such as stand-alone storage, are not disadvantaged. Where recapture results from a lender foreclosure, recapture liability should be assessed on the transferor.
Sale of Business Exception
A second recapture issue is also preventing transacting in the transferability space. There is concern among potential tax credit buyers about upstream buyouts of entire lines of business causing recapture. Many developers are organized as multiple layer chains of single-member limited liability companies. The multi-tiered disregarded entity structure is often necessary for debt financing or for accounting reasons. Potential tax credit purchasers are hesitant to purchase tax credits from sellers perceived as likely to sell all lines of business. An exception to the rule that recapture is assessed on the buyer when there is an upstream sale of an entire business would alleviate this concern and help to open the transferability market. Recapture could still be assessed against the buyer when the project or project company is sold directly.
Prohibition on Double Recapture
The final regulations should make clear that recapture must only be recognized once. If the transferor reflects a recapture on its tax return, then recapture cannot and will not be assessed against the transferee and the transferor has no obligation to notify the transferee of the recapture.
Allow transferability in passthrough leases
Treas. prop reg. sec. 1.6418-2(a)(4)(iii) would provide that “[n]o transfer election is allowed for eligible credits that are not determined with respect to an eligible taxpayer as described in paragraph (d) of . . . section [1.6418-2],” and includes as an example of such situation a section 48 credit allowable to an eligible taxpayer pursuant to an election made under section 50(d)(5) (commonly referred to as a “lease passthrough structure”). Treasury and the IRS's rationale for this position was that the ITC is not “determined” with respect to the lessee, meaning that the lessee does not own the underlying property and is only allowed the credit due to an election by another taxpayer.
We request that Treasury and the IRS reconsider the inclusion of lease passthrough structures in Treas. prop reg. sec. 1.6418-2(a)(4)(iii). For the reasons discussed below, allowing a lessee that is participating in a lease passthrough structure to transfer the ITC is consistent with the Code and the underlying policies motivating the underlying ITC, and the rationale of Treasury and the IRS for not allowing a lessee to claim the credit is not compelling.
History of ITC and Lease Passthrough Election Support Allowing Lessee to Transfer Tax Credits. The first iteration of an ITC was enacted as part of the Revenue Act of 1962 as part of a plan to spur allocation of capital to new property to stimulate the U.S. economy and encourage investment of capital domestically. As part of this enactment, former section 48 allowed a lessor of credit-eligible property to elect to pass the credit through to the lessee of such property. The stated rationale of Congress for allowing lessees to claim the ITC in these circumstances was to reward the lessee, as it was often a lessee's desire for an asset that led the lessor to invest in new property. The original draft of former section 48 allowed this election to taxpayers who were in the business of leasing property, but the availability of the election was expanded by a Senate amendment to include any taxpayer who leases eligible property, thereby indicating that the incentive was supposed to have a wide scope. Tax Court interpretations also indicate that the passthrough lease rules are to be construed liberally, which is consistent with the underlying purpose of the credits.
Furthermore, in enacting this legislative scheme to accommodate lease passthrough structures, Congress merely was implementing a rule of administrative convenience. In particular, the lease passthrough election obviated the need to engage in a more complicated and costly sale-leaseback transaction in order for a taxpayer to be entitled to calculate the credit based on fair market value of a property (rather than on its cost). Reducing the hurdles that must be cleared in order to qualify for an incentive makes that incentive more powerful. Thus, it was entirely rational for a Congress that was seeking to encourage investment to provide for a simple elective regime under which lessors and lessees, acting collectively, could pass through the ITC to the eligible lessee. The proposed regulations under section 6418, as released, would upend that balance by again putting lease passthrough structures at an unequal (and disadvantaged) position as compared to sale-leaseback structures, precisely the outcome that Congress sought to avoid in 1962 at the time of the introduction of the ITC.
Moreover, some of the key policy concerns (e.g., potential for abuse and fraud) that may have motivated the Treasury and IRS to conclude that a lessee should not be eligible to transfer credits have already been addressed under existing ITC-related law, including the rule providing that where an asset is leased to a member of the same controlled group, the ITC is appropriately claimed based on the lessor's basis (not FMV), and rules providing that certain lessors (e.g., those subject to taxable income constraints, such as real estate investment trusts) couldn't avoid statutory taxable income constraints using passthrough lease elections. Thus, if Treasury and the IRS are concerned that the transfer of a credit that has passed through to a lessee could result in abuse, Treasury and the IRS could, consistent with past practice related to the ITC, address these concerns with a more narrowly tailored approach that targets situations where abuse is likely. For example, the regulations under section 6418 could confirm and clarify that a credit of a lessee (assuming the final rules permit a lessee to transfer a credit) could not be transferred to a corporation that is in the same controlled group as the lessor corporation (consistent with former section 48(d)(1)(B)) unless that transferee claims the ITC on the lessor's basis (and not the fair market value of the applicable property). Ultimately, the proposed regulations take an overly broad approach to prevent abuses of the transfer election under section 6418 that would be better addressed through more narrowly tailored regulations related to the passthrough election itself promulgated under the regulatory grant of authority to tailor the rules under current section 50(d)(5).
ITC is Determined with Respect to the Lessee. As noted above, the entire stated rationale of Treasury and the IRS in not allowing a lessee to transfer an ITC is that the credit is not “determined” with respect to the lessee, implying that the credit is computed solely with respect to the lessor and that the lessee only claims the lessor's credit as a result of the election of the lessor (consented to by the lessee). For reasons discussed below, this rationale is not persuasive.
Importantly, the lease passthrough structure is not a regime by which the ITC solely is “determined” with respect to the lessor. The Code is clear (at former section 48(d)(3)) that the lessee is treated, for purposes of the ITC, as though it were the actual acquirer of the property. Furthermore, Treas. reg. sec. 1.48-4 makes clear that the ITC is in fact “determined” based on qualities of the lessee as well as the lessor: the lessor and the credit property need to meet the requirements of the credit, but the lessee also must be the original user of the property, and the taxable year in which the credit is taken into account is the taxable year of the lessee in which the applicable property is placed in service. Recapture determinations are also made with regard to the lessee. Accordingly, the better view is that the ITC is determined in respect of the lessee and the lessor in a lease passthrough structure. We therefore see little reason as to why Treas. prop reg. sec. 1.6418-2(a)(4)(iii) should prevent a lessee in a lease passthrough structure from transferring, pursuant to section 6418, the ITC that is passed through to that lessee. To the contrary, Treas. prop reg. sec. 1.6418-2(d) suggests that such a lessee should be permitted to transfer the ITC, precisely because the ITC is, in fact, determined in substantial part with respect to the lessee.
Moreover, in permitting a lessee in a lease passthrough structure to be an eligible taxpayer for purposes of this transferability regime, Treasury and the IRS could easily require that the lessee register the eligible credit property and comply with all other transfer requirements to transfer such eligible credits. Doing so would ensure that Treasury and the IRS experiences no incremental administrative burden from a transfer of an eligible credit by a lessee, as the lessee would provide all relevant information necessary to make a determination whether a transfer is valid and Treasury and the IRS accordingly could track and trace the transfers of these credits without meaningful incremental burden. Treasury and the IRS also could revise Treas. reg. 1.48-4 to require a lessor to commit to not making an election to transfer under section 6418 of a passed through credit, thereby addressing any concern that the ITC might be claimed more than once with respect to a single property.
1For purposes of this discussion, the bonus credits are the 10-percent adders for section 45 or 48 tax credits (respectively) for meeting the domestic content or energy community requirements, and the 10- or 20-percentage point increases for investments in low-income communities under section 48(e).
2Note that this proposal to allocate bonus credits separately for transfer purposes does not affect how bonus credits are to be allocated to partners in a partnership under subchapter K. Presumably, Treasury regulations would allocate the bonuses to partners in the same proportion as the base credits are required to be allocated to the partners. This proposal does not change that rule. Rather, once the tax credits are allocated to the partners, the partnership could elect whether and how each partner's separate allocation is transferred, including whether the bonus credits are distributed or transferred (and to whom).
3The government's administrative burdens would be even greater with respect to PTCs because the IRS would be required to monitor compliance with respect to the bonus disallowance for each of the four transferees for each of the years in the 10-year production period.
4The preamble to the proposed regulations describes this timing rule as a “safe harbor.” In fact, the timing rule is part of the definition of “paid in cash” of Treas. reg. sec. 1.6418-1(f). It is a requirement rather than a safe harbor because no other alternative or general rule exists in the proposed regulations.
6Specifically, the discussion of “Alternatives Considered” under the Regulatory Flexibility Act section of the preamble says that Treasury and the IRS considered administering section 6418 only with respect to information filed with tax returns, but rejected this option because it would increase the opportunity for duplication, fraud, improper payments, and excessive payments. However, the discussion does not indicate how the registration requirement addressees these concerns.
8Prop. Treas. reg. sec. 1.6418-4(b)(5)(ii) and (x) indicate that the registration portal and future guidance may require even more information.
9See the comments herein that suggest allowing transferors to group qualified properties.
10See the discussion herein regarding estimated tax payments.