MBA Candidate at UNC Kenan-Flagler Business School | Tax Equity | Energy Finance | M&A | Corporate Development | Energy Transition | Strategy

Transferability Risks: A Critical Examination

Navigating the transferability of tax credits in renewable energy projects is a delicate venture laced with a spectrum of risks. From recapture pitfalls to stringent qualification requirements, the fiscal landscape is as complex as it is rewarding. Understanding these risks is not just about safeguarding investments; it’s about ensuring the seamless flow of benefits across the intricate web of stakeholders involved. Let’s delve into the major risks associated with transferability, each a critical piece in the a of Tax Credit Transactions:

  • Re-Capture Risk:
    Recapture risk refers to the possibility of having to repay the ITC to the government if certain events occur within a five-year period after a renewable energy property is placed in service. This period is crucial, as it determines the extent of financial liability in case of the following recapture events.
    • Cessation of Qualifying Use:
      If at any point during the five-year recapture period the property ceases to be used as a qualifying renewable energy source, this could trigger the recapture of the tax credit. Consider a solar farm that’s initially set up to contribute electricity to the grid. If, within the recapture period, it’s converted into land for agriculture or any non-renewable purpose, this cessation of its original, qualifying use would trigger recapture. Another example could be a wind turbine that’s dismantled or left inoperable and not repaired within a reasonable time frame.
    • Change in the Ownership Interest:
      This trigger event is concerned with the stability of the project’s ownership. If there’s a change in who owns the project or the entity that initially claimed the ITC, it could trigger recapture. For instance, a founding partner owning 60% of a renewable energy company who sells off 50% of their stake has altered the project’s ownership structure and will lead to a recapture event.
    • For Production Tax credits for Carbon Capture, if captured CO2 leaks from its secure storage within the critical first three years, the company responsible must proportionally reduce its claimed tax credits. For example, if a leakage incident results in a $25 tax credit recapture, the company’s year three tax credit would decrease from the expected $150 to $125.
  • Qualification Risk:
    When transferring the tax credits from one party to another, qualification risks are another major risk to be considered by the buyers. A primary concern is ensuring the IRS approves the full cost basis of the project, which forms the foundation of the tax credit calculation. For instance, if a solar energy company develops a project and then transfers the ITC to a financial entity, there’s a risk that the IRS might challenge the cost basis initially claimed by the developer. This scenario could lead to a reduction in the tax credits.
    Another pivotal aspect is compliance with prevailing wage and apprenticeship requirements, particularly if the project aims to claim additional credit adders. For instance, when a wind farm project, initially compliant with these labor standards, is transferred to a new owner who may not uphold these standards, potentially resulting in the loss of the adders.

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