Tax Reform and Implications for Renewable Energy Finance
Written By: Stratton Report
December 8, 2017
We spoke to David Burton, leader of Mayer Brown’s Renewable Energy group in New York, to get his insights on Tax Reform and the Implications for Renewable Energy Finance.
David K. Burton is a partner in Mayer Brown’s New York office and a member of the Tax Transactions & Consulting practice. He leads Mayer Brown’s Renewable Energy group in New York. He advises clients on a wide range of US tax matters, with a particular emphasis on project finance and energy transactions. In addition, he advises clients on tax matters regarding the formation and structuring of domestic and offshore investment funds. Earlier in his career, David was the managing director and senior tax counsel at GE Energy Financial Services, one of the world’s leading investors in energy projects.
He also is a co-editor of Tax Equity Times, which addresses issues at the intersection of renewable energy and tax policy in the United States.
Stratton Report: What is the tax reform package’s impact on renewable energy?
David Burton: The first thing to say is that it’s not law yet, the House and the Senate passed bills with material differences, and they now have to go to conference committee to be reconciled. It’s hard to predict exactly what’s going to come out of that process, and then the reconciled bill has to be passed by each chamber; passage of the reconciled bill by each chamber is likely given the Republicans’ control of both chambers, but it still has to happen. There will be material changes made in the conference committee process.
We’re all in the fog because we don’t know what’s going to happen in the conference committee. In terms of the reduction of the corporate tax rate, which is not helpful for tax equity and renewables, the House bill reduces it to 20% starting in January, the Senate bill reduces it to 20% starting January 2019, and then the President this weekend said that he might consider 22%; it’s probably going to be one of those three, but we don’t know which. Expensing is slightly beneficial to the renewable energy industry on the margins because you don’t have to expense if you don’t want to so long as the investment vehicle is a newly formed partnership, and if you do, it’s very accelerated cost recovery. If you’re doing a lease or if you’re doing a partnership transaction whereby the capital account calculations can tolerate the expensing amount going through, then that’s a pretty powerful tax benefit, but I think a lot of tax equity partnership transactions actually won’t be able to handle full expensing so they will probably elect out. That remains to be seen.
And then the big thing that everybody is kind of up in arms about is the Base Erosion and Anti-Abuse Tax (BEAT) provision that says that if you have your corporation and you have over 500 million dollars of gross receipts, that you have to ask the question of “are four percent or more of your deductions attributable to payments to your foreign affiliates?” and if yes, you then have to do this alternative tax calculation. It’s quite complicated, but basically, the calculation is, you don’t get to take those deductions for payments to your foreign affiliates, until 2026 you don’t get any energy tax credits (you do get research and development tax credits, and then you apply a 10% tax rate (or 11% if you are a bank), and if that results in a higher tax than your normal tax calculation, you have to pay that higher amount. The concern is that if it results in a higher amount, then until you have tax credits accruing in 2026 or later, you’re not getting any benefit for your energy tax credits, so tax equity investors may be reluctant to make energy tax credit investments because there’s a risk they may not get any benefit from them.
SR: What percentage of the tax equity providing communities will be affected by this?
Burton: “I don’t know,” which is not a very satisfying answer, but there’s no way to have visibility to the tax calculations of the tax equity investors to determine that. I don’t have a visibility as to what their tax return looks like, and their public financial statements are not helpful because the payments that would trigger BEAT are between affiliates.
I think likely it’s going to be a problem for US banks and insurance companies that are foreign-owned. So the names that come to mind are Royal Bank of Canada, MUFG, Santander and Allianz. It tends to be that US banks and insurance companies that are owned by foreign parents make large payments to foreign affiliates often in the form of intercompany interest, so those are going to be problematic under this new law once enacted.
My guess is that US banks with foreign parents are going to be problematic. I would think that large banks insurance companies that are publicly traded in the US are less likely to have a problem, but there’s a possibility they may have some fancy international tax planning going on, which could cause a problem whereby they’re making significant payments to a foreign affiliate and then they’ll have to decide whether to continue international tax planning and shut down their tax credit business, or continue with their tax credit business and stop the international tax plan. But I don’t have sufficient visibility in their tax returns to know that one way or the other.
If I was trying to make a sort of an educated bet, I would say banks with foreign parents, insurance companies with foreign parents; it would pretty likely be a problem for them. US-owned banks and insurance companies, that is banks and insurance companies publicly traded in the US, are less likely to be a problem; I’d be a little bit if surprised they actually triggered it.
SR: How about the general impact of the fact that if the corporate rate goes down, that makes tax equity presumably proportionately less attractive?
Burton: Yes, it’s a problem. I did seminars with Alpha Energy Advisors, and we showed calculations about that, and basically, it’s almost neutral to a solar project because solar projects have richer offtake contracts, therefore, they get more benefit from a lower tax rate.
In contrast, wind projects tend to have lower priced offtake contracts so they get less benefit from a lower tax rate. The bottom line is wind projects are going to feel more pain from reduced tax rate than solar projects.
Not that solar will be happy about a lower tax rate, but it’s kind of a small-to-neutral impact to solar, but a pretty big impact to wind.
SR: I’m just trying to understand how large an impact BEAT is likely to really have on tax equity, and thus, how large is this likely to have on renewable financing? I mean in the level of renewable activity. I’ve heard some fairly dire comments but I didn’t know how seriously to take them.
Burton: I mean, obviously Royal Bank and MUFG are big players, but they’re not the whole market, right? So a) I am hopeful that this problem gets solved in conference committee and b) it would be unfortunate to lose Royal Bank, MUFG, and Allianz, but I don’t think it’s a fatal blow.
SR: By the way, isn’t the House version reduced? They didn’t do the BEAT provision, but didn’t they cut the Investment Tax Credit (ITC) and Production Tax Credit (PTC) in half? Wasn’t there some negative consequence there?
Burton: Each of wind and solar suffered blows in the House’s tax credit provisions. The House bill would eliminate the permanent 10% solar ITC that applies under current law after 2023, which is a blow to solar. So they said, okay, we’re getting rid of that, and they said we’re getting rid of the PTC inflation, adjustment, and so the PTC goes back to its nominal amount unadjusted for inflation, which is 1.5 cents a kWh, as opposed to 2.4 cents a kWh, so that’s a blow to wind.
The House bill also had language about safe-harboring wind projects and about having to actually continuously construct to have a wind project qualify for a higher tax credit amount based on the year construction began. The House bill’s language suggests that projects would not be able to take advantage of this IRS-created four-year rule. That rule provides that if the project is done within four years of when you’re deemed to start, you’ll be deemed to have continuously constructed and qualified for the higher tax credit available in the year construction started.
Well, while the House bill appeared to say, “no, we mean you have to really have hard hat guys out there Monday through Friday, 9-5, doing something.” They then backed off on that and there was legislative history that provided, “we’re not changing the IRS start of construction rules,” but that was just legislative report language that didn’t actually get manifested in the statutory language yet, so that remains to be seen.
I’m pretty sure those provisions about the amount, as well as qualifying for tax credits, will come out of the reconciled bill that the conference committee produces because there are Republicans like Chuck Grassley (R-Iowa), and probably Dean Heller (R-Nev.) as well, who would vote against a bill that did that to renewable energy, and so to avoid losing those votes, they’ll probably take them out.
SR: But it’s possible that the BEAT provision might?
Burton: Right, although my guess is that it’s going to get fixed. It was picked up by the Washington Post and Bloomberg, it’s getting a fair amount of attention, and the BEAT problem is not just a problem for renewable energy, it’s also a problem for low-income housing, new markets tax credits and historic tax credits. Particularly the low-income housing industry is pretty large and pretty powerful. I think that’ll probably get fixed, but it still has to happen.
SR: There was some speculation that renewable energy might have gotten included under the BEAT rules almost by accident.
Burton: I mean, the rules are very complicated but they clearly thought about giving R&D tax credits better treatment than every other tax credit. So the person writing that language clearly did that, so there was some thought behind it.
They may have been thinking, “well, these foreign-owned companies don’t really do tax credits, what’s it matter?” That may have been their thought. There may have been a lack of appreciation, but I think they were pretty conscious about the words they wrote.
SR: Let’s talk about the research & development (R&D) of credit. There was a certain amount of negative press from people who were saying like that the R&D credit, which was then illustrated by a comment by the Chairman of Massey Energy, a coal producer? I didn’t understand exactly the connection between R&D and coal production. Do you understand why he was upset or why it had negatively affected him?
Burton: The article that I saw was the CEO of Murray Energy, a coal company, who was critical of the Senate bill. His critique related to limitations on interest deductions and the retention of the corporate AMT with a 20% tax rate. The Senate bill’s handling of AMT at a 20% tax rate was just a mistake. If the corporate AMT is going to use a 20% tax rate and the regular corporate tax rate is 20%, then effectively the corporate AMT becomes the only corporate income tax. That clearly was not the intent. There are now discussions on Capitol Hill to lower the corporate AMT tax rate to 15% or possibly lower. If that is done then the corporate AMT would serve its original purpose of ensuring that corporate taxpayers do not have too much fun with certain tax incentives, as opposed to what the Senate bill does which is have the corporate AMT supplant the rest of the corporate tax rules.
I believe that if the corporate tax rate is going to be 20% then the corporate AMT rate should be 11% because that is a comparable ratio to current law in which the corporate tax rate is 35% and the AMT rate is 20%.
SR: He was eloquent on the subject. I believe he said, “These guys are patting themselves on the back for doing tax reform. In the meantime, they’re putting me completely out of business.”
Burton: And Trump likes coal!
SR: That’s what I thought. I thought to myself, is it possible these guys did this so fast they didn’t quite always know what they were doing?
Burton: They made a lot of mistakes. I mean, they’ve already admitted that the Senate bill has a lot of mistakes and they’re saying, “oh, we’ll fix it in conference,” but there are mistakes that haven’t been identified yet that I’m sure that are in there due to the nature of the process.
There are definitely going to be some unintended consequences and some surprises as time goes on, and people will look into this more and figure it out better.
SR: Do you think the corrections, if they’re not made in conference, there might be a possibility of later corrective legislation?
Burton: There’s a long history of technical corrections; the legislative process has always been an imperfect process by imperfect human beings, so technical corrections are very common and there’s a long history of it.
And they’re usually relatively non-controversial because they’re supposed to be the sort of things which don’t really move the revenue needle one way or another, and it’s kind of fixing things or saying, “oh well, this is making it consistent with the way it was originally scored,” but it can take years. Sometimes there’s a number of years that can pass between when the first bill is enacted and when the technical correction is enacted, and there’s no time limit on how long you have to do with technical corrections, so even if it’s a decade later, you can still do it and it can take a while. They try not to drag it out that long but just given politics and other distractions at times, it can go quite long.
SR: There was a meeting on Community Choice Energy in California, and at that meeting, one of the Community Choice Aggregators (CCAs), I believe it was Marin Clean Energy, said that they anticipated a future when they would build their own solar facilities, and they said that, at the moment, the only reason that they go out and do PPAs with developers is that that allows them to utilize the ITC, but since the ITC is kind of going away, they were looking forward to a not-too-distant future in which developers would become sort of contractors, rather than taking the traditional sell-and-hold-the-asset position. The end users would more or less own the assets directly.
I’ve also noticed that in the wind area, there’s been a tendency, at least for some utilities, particularly Xcel, to build their own wind farms and just rate-base them in that sense. So I’m just wondering, am I seeing a trend? Is this something that developers are thinking about, that the future in which building up large portfolios of assets, or it may not actually be a workable strategy anymore in not that many years?
Burton: Well, the aggregators are composed of municipalities, so they’re not taxpayers, and it’s true the ITC is either going to 10% at some point or going away, depending on which version of tax reform is passed, but they’re still accelerated depreciation or possibly expensing which is pretty powerful, and an aggregator wouldn’t be able to take advantage of expensing or accelerated depreciation, so if they wanted to get some indirect benefit for the immediate tax write off, they still wouldn’t need to do a PPA and have the project owned by a taxpayer who charges a lower PPA rate due to the expensing benefit.
The expensing benefit would be equal to 20% of the cost of a project, so I think that your aggregator was kind of overlooking that expensing or accelerated depreciation is a big benefit too, not just the ITC. And under the Senate bill, the expensing benefit would be 35% for 2018, which would decline to 20% in 2019; that would cause a big push to buy projects in 2018 and capture the additional 15% of tax benefit.
SR: I’m not arguing their point of view, I’m just trying to figure out if this attends a shift. Is it also true in wind, however. It did seem as though there was a somewhat greater shift in the wind sector.
Burton: First of all, Xcel’s a taxpayer, right? Xcel, Exelon and Southern are taxpayers, so they don’t have the municipality issue. Second of all, normalization, which is this rule that makes it difficult for utilities to use ITC does not apply to the PTC, so it’s pretty easy for a utility to own its own wind project. A regulated utility owning its own solar project is a little bit more difficult to do due to the application of the tax normalization rules to a rate-based legal entity.
SR: Do you think that the shifts that we’re talking about, I mean depending on which version of the legislation or what portions are enacted, do you think that will shift away from developers developing financing and holding is going to happen in wind? Do you think that might be a little bit more pronounced in wind?
Burton: They will be more pronounced in wind. As you pointed out, it is already happening. Xcel is not the only utility to rate-base wind, so that’s going to continue to happen.
SR: Well, you say that it’s hard for utilities to use the ITC, but I was reading and got the impression that a certain amount of the utility-scale solar that’s being built in the Southeast seems to also be rate-based, as best one can tell. Am I correct about that or is there a developer in the middle of that somewhere?
Burton: Developers are in the middle of it.
SR: And they’re just keeping quiet about that?
SR: Well, that’s all the questions we have for today. Thank you for your time.
Burton: Well, glad to talk. Interesting questions. Good luck to you, thank you so much.