Explaining the Impacts of the House and Senate Tax Reform Bills on Publicly Traded Clean Energy Companies

By Stuart E. Leblang, Michael J. Kliegman  and Amy S. Elliott

There has been mild hysteria concerning the impact tax reform will have on public companies in the renewable energy space.  In particular, the Senate’s base erosion and anti-abuse tax (BEAT), if enacted, would reportedly cost the industry “billions of dollars in project finance,” ¹ “bring a booming sector to a halt,” ² and “result in broad instability and uncertainty for businesses and investors.”  ³ Are these claims overblown?

The BEAT will cause some investors to leave the renewables financing market, resulting in a short-term reduction in the pool of investor dollars for energy tax credit deals.  But nothing in tax reform reduces the fundamental value of energy tax credits overall.  They still give certain U.S. companies the ability to achieve a dollar-for-dollar reduction in their tax liability.  In 2016, investors committed about $11 billion of equity to renewables deals in exchange for tax credits.  ⁴ 

Purely U.S. investors will not be impacted by the BEAT.  We expect that, as the renewables financing market tightens, existing BEAT-immune investors will benefit from higher returns, causing them to increase the total amount of their investments (even though the individual size of each investment may decrease).  In addition, new BEAT-immune investors could be attracted to the market.  Tax reform will not cause the renewables financing market to seize up.  Tax credit deals will continue, but there will be disruption.  Some deals at the margins may fail given the higher rates of return that investors will be able to command, leaving some developers short of cash to get their projects funded.

• Renewable project financing is heavily dependent on the value of energy tax credits. Traditionally, 35 percent to 40 percent of a solar project or 55 percent to 60 percent of a wind project is financed by the investor seeking tax credits.  Any proposals in tax reform that could eliminate the tax credit value for some investors will disrupt these deals and potentially be a material item for companies dependent on such financing.
• The BEAT would likely shrink the available pool of capital for certain companies that develop wind and solar energy projects by partnering with investors seeking tax credits, slowing the rate of growth of such companies and reducing the number of new projects. However, if the investor is purely domestic, the BEAT does not apply.
• If lawmakers decide in conference to retain the corporate alternative minimum tax (AMT)—which was in the Senate bill but not the House bill, even at a lower rate (11.4 percent has been floated⁵ )—that would put further pressure on financing availability. Lawmakers claim that repealing the corporate AMT, currently set at a rate of 20 percent, is a priority.⁶ 

Investors Seeking Energy Tax Credits

There are a handful of large public companies with stakes in this issue.  Companies that manufacture solar ⁷ panels and wind ⁸ turbines and clean energy power generation companies (in particular independent power producers) pay close attention to the various tax incentives (including the Section 45 production tax credit or PTC for wind and the Section 48 investment tax credit or ITC for solar) that help keep their businesses flush with outside investment dollars for their capital-intensive projects.

While the credits themselves are not immediately repealed by either the House or the Senate, the Senate’s BEAT could cause some investors to exit the market, reducing available capital for an industry that relies on tax credit partnerships to maximize investment.

Under current law, investors in clean energy deals receive credits they can use to reduce their U.S. taxes.  These investors, which primarily include large foreign and domestic banks, small U.S. banks, multinational corporations and insurance companies (with foreign entities traditionally investing through a U.S. subsidiary), only enter into such deals because they believe they will be able to fully utilize the credits.

How the BEAT Works

The Senate’s BEAT is essentially a minimum tax regime that, if it applies, cannot be reduced by energy tax credits and will not allow the credits to be carried forward.  It keys off base eroding payments made by a U.S. corporation (no matter if the parent is U.S. or foreign; it does not apply to partnerships) to a related foreign corporation.  Domestic-to-domestic payments are not hit.  Payments to third parties are not hit.  The base eroding payments must be deductible by the U.S. entity, but do not include payments for cost of goods sold or payments for services provided with no markup.

If the BEAT applies (which happens if, among other things, the U.S.  corporation has average annual gross receipts of at least $500 million and the amount of its base eroding payments during the year is at least 4 percent of its total allowable deductions), the U.S. corporation must add back into its taxable income the full amount of the base eroding payments and is taxed at 10 percent of that larger amount (as opposed to the corporation’s regular tax liability, which would tax at 20 percent the smaller amount of taxable income).  No business tax credits (with the exception of the research credit) can be used to reduce the BEAT’s alternative tax amount.

The BEAT has the potential to directly impact certain investors in tax credit partnerships.  Such investors can have complex structures involving chains of domestic and cross-border corporations that could take the income distribution from the deal and pass it along to a foreign affiliate (even if the ultimate parent is domestic and even if the initial recipient, the party to the deal, is a partnership).

BEAT’s Impact on Tax Credits

The BEAT has the potential to curtail the value of certain existing and future deals.  Some investors could walk away from all pre-existing and future deals while others could reduce their investment dollars going forward.  Investors that are purely domestic and are therefore not impacted by the BEAT could benefit from a competitive advantage.

Although an exception to the BEAT was provided for qualified derivative payments (which may apply to provide relief if the investor is a multinational bank), any deal that triggers certain payments from a U.S. corporation to a foreign affiliate (which would be less likely to be an issue in solar projects) could be tripped up.  With wind projects, however, the tax credits accrue over 10 years, which would mean that if the BEAT is potentially applicable, investors would want to project out their BEAT liability over a long window in order to determine if the deal is worthwhile.  It is a critical issue, as the BEAT could cause the energy tax credits to be lost forever.

• We know of at least $1 billion in renewable energy investments—not just by foreigners—that are currently on hold pending tax reform. The BEAT could potentially impact $100 billion of certain power investments over the next 10 years.
• Industry groups—including the Solar Energy Industries Association, the American Wind Energy Association⁹ and the American Council on Renewable Energy¹⁰ —are working to make sure that policymakers understand the implications and consider amendments that might allow energy tax credits to be used to reduce the tax, allow unused credits to be carried forward or provide transitional relief.
• Despite their efforts, lawmakers seem convinced such relief would impact the BEAT’s revenue score, requiring offsets. Industry experts argue there would be no negative revenue impact from such relief, as investors subject to the BEAT will simply exit their positions, possibly triggering a deductible loss, in which case relief could raise money.

Public investors in clean energy companies need to consider tax reform proposals other than just the BEAT to get a comprehensive view of which market participants could be compromised.  While the dramatic reduction in the corporate income tax rate (from 35 percent to 20 percent) necessarily reduces the demand of energy tax credits for deal investors (with a likely lower tax liability), such credits can still serve to plug a hole when pricing out a deal.

Changes to the PTC and ITC

The Senate bill largely leaves the PTC and ITC unchanged.  Under current law, the PTC is being phased out and will be unavailable starting in 2019, while the ITC, which is now at 30 percent, will reduce in value to 10 percent beginning in 2022.

However, the Senate bill preserves the corporate AMT, which, like the BEAT, could reduce the value of the credits (although the AMT, unlike the BEAT, can be offset by any ITCs without limit and by any PTCs for four years).  As mentioned earlier, lawmakers could either decide to repeal the corporate AMT altogether or possibly preserve it, but at a lower rate.

The House bill makes significant changes to the PTC and ITC, reducing the value of the PTC in a way that could harm ongoing projects and repealing the ITC effective in 2027.

Interest Deduction Limitation

Independent power producers have been asking lawmakers for relief from the amended Section 163(j) limitation on the deductibility of net interest expense, which is particularly harsh in the Senate as it is capped at 30 percent of earnings before interest and taxes (EBIT) but after depreciation and amortization.  The limit is more generous in the House, designed as 30 percent of EBIT before depreciation and amortization (EBITDA).

While certain taxpayers were given a pass on the limitation—including those in the trade or business of providing electrical energy, but only if the rates for furnishing such energy are set by a government regulator—the pass did not extend to unregulated power producers.

• Most clean energy developers will be subject to the 30 percent limit. That said, in the case of solar deals, the depreciation deductions generated in the early years usually create substantial losses, negating the harm of such a limitation.

Impact of Expanded ‘Expensing’

Both the House and Senate would expand the Section 168(k) additional first year depreciation deduction to effectively allow businesses a 100 percent, immediate write-off of their full investment in certain short-lived capital property (such as machinery and equipment) for property placed in service after September 27, 2017.  The 100 percent deduction expires in 2023 in the House.  The Senate phases it out beginning in 2023, so that it goes down 20 percentage points per year from 80 percent in 2023 to 20 percent in 2026, with full repeal in 2027.

Because these deals involve the types of property eligible for the Section 168(k) benefit, the expanded “expensing” provision will increase the existing 50 percent bonus to 100 percent, boosting the yield for tax credit deal investors right away.  However, the extent to which this benefit makes a real difference depends on the particular circumstances of each deal.

^{[1] “[The BEAT could potentially cost] the renewables industry billions of dollars in project finance,” Emma Foehringer Merchant, Dec. 1, 2017, “Senate Tax Bill Passes With BEAT Provision,” Greentech Media (https://www.greentechmedia.com/articles/read/beat-provision-tax-bill-vote#gs.fFnV1EU).}

^{[2] “[The BEAT] would simply undermine the financial structure that is critical for renewable energy and bring a booming sector to a halt,” Justin Worland, Nov. 30, 2017, “The Tax Reform Bill Could Hurt Wind and Solar Power,” Time (http://time.com/5042881/tax-reform-bill-solar-wind-power-renewable-energy/).}

^{[3] “[If the BEAT and the corporate AMT are retained], they will result in broad instability and uncertainty for businesses and investors across many sectors, including the clean energy sector,” Dec. 2, 2017, “Clean Energy Leaders Statement on Passage of the Tax Cuts and Jobs Act in U.S. Senate,” American Council On Renewable Energy (http://www.acore.org/resources/press- releases/6306-clean-energy-leaders-statement-on-passage-of-the-tax-cuts-and-jobs-act-in-u-s-senate )   .}

^{[4] https://www.cohnreznickcapital.com/wp- content/uploads/2017/09/CohnReznick_USRenewableEnergyBrief_TaxEquityLandscape.pdf}    

^{[5] “One idea business groups could push, if it becomes clear that the AMT will stay in a final bill, is to seek a lower AMT rate of 11.4 percent, which is proportional to the 20 percent AMT rate and 35 percent corporate rate difference under current law,” Laura Davison and Victoria Graham, Dec. 5, 2017, “Senate’s Alternative Minimum Tax Creates Friction With House,” Bloomberg BNA.}

^{[6] Bloomberg News, Dec. 5, 2017, “Brady Says Ending Senate Bill’s Corporate AMT Is ‘Priority,’” Bloomberg BNA.}

^{[7] “Solar industry stocks are slammed in today’s trade as the tax bill passed by the U.S. Senate contains provisions that could harm wind and solar energy investment and deployment,” Carl Surran, Dec. 4, 2017, “Solar stocks fade on dim view of Senate tax bill provisions,” Seeking Alpha (https://seekingalpha.com/news/3316134-solar-stocks-fade-dim-view-senate-tax-bill- provisions).}

^{[8] “Shares in the world’s biggest manufacturer of wind turbines have tumbled more than 20% in November, whacked in part by worries about a potential hit to a production tax credit that has helped drive construction of U.S. wind farms,” Victor Reklaitis, Nov. 20, 2017, “This green-energy stock is getting whacked by tax-reform fears—here’s how to play it,” Barron’s (https://www.marketwatch.com/story/this-green-energy-stock-is-getting-whacked-by-tax-reform-fears-heres-how-to-play-it- 2017-11-20 )}

^{[9] http://www.aweablog.org/critics-getting-wrong-wind-power-tax-reform-debate/}

^{[10] “Major financial institutions have indicated that, under such a regime, they would no longer participate in tax equity financing, the principle mechanism for monetizing credits.  The tax equity marketplace would collapse under these provisions, leading to a dramatic reduction in wind and solar energy investment and development,” Nov. 29, 2017, “Joint Letter Calling on Senate to Repair Provisions that Undermine Renewable Energy in the Senate Tax Bill,” ACORE, AWEA, CRES and SEIA (http://www.acore.org/images/publications/ACORE_AWEA_CRES_SEIA_LetterOnSenateTaxBill_Nov29.pdf).}