United States: GOP Tax Bill Proposes Changes To The Renewable Energy Industry's Tax Incentives

On Thursday, November 2, Republicans in the US House of Representatives released their proposed tax reform legislation, providing for massive alterations to tax law. The proposed legislation would trim tax benefits applicable to the wind and solar industries, while broadening the scope of the application of the "orphaned" energy tax credit. Further, it would eliminate the tax credit for electric vehicles starting in 2018. The proposed legislation is subject to further amendments and may not be enacted into final legislation.

Continuity of Construction. Pursuant to current law, the production tax credit (PTC) and investment tax credit (ITC) phase out over time, with the level of credit for which a renewable energy project qualifies being based on when the project began construction relative to various deadlines that determine the level of PTC or ITC. Under the proposed legislation, for any renewable energy project to qualify for a specific level of PTC or ITC, there would need to be continuous construction on such project from the deadline for the specific PTC or ITC level through the date the project is placed in service.

The concept of continuous construction does not exist in the current PTC and ITC provisions of the Tax Code. It was adopted by the IRS as an administrative matter in Notice 2013-29. However, the IRS later, under Notice 2016-31, created a safe harbor to enable projects to avoid application of the IRS's "continuity" requirement. To qualify for the safe harbor, a project must be placed in service within four calendar years after the end of the calendar year in which construction began. The proposed legislation would effectively codify the continuity requirement and eliminate the safe harbor. Further, these changes appear to apply to all projects that have not been placed in service as of the date of enactment of the proposed legislation, regardless of whether construction of such projects began before enactment.

Further, Notice 2013-29 provided a more lenient continuity requirement for projects that started construction by incurring 5 percent of their total cost. That is, the developers of such projects only have to use "continuous efforts" as opposed to "continuous construction." "Continuous efforts" includes tasks such as making payments on contracts and obtaining permits. Because the proposed legislation uses the terminology of "continuous program of construction," it would appear to eliminate the lenient continuous efforts standard for all projects.

Notice 2013-29 excuses from its continuous construction requirement stoppages in construction for events like delays in obtaining permits, financing (for up to six months) or bad weather. We are hopeful that such delays in construction would still be excused in the event the proposed legislation is enacted.

This proposed legislation could put in jeopardy a significant portion of the gigawatts of new capacity from the new wind projects on which developers start construction in 2016 but for which they have not pursued "a continuous program of construction" based upon the expectation that they could pause and finish within the four-calendar-year window provided under Notice 2016-31.

Moreover, the proposed legislation applies the same actual continuous program of construction requirement to ITC eligible projects, such as solar. The ITC for solar only starts to ratchet down for projects that start construction in 2019 or later. However, it seems unlikely that a developer would start construction on a residential or commercial solar project in 2019 and have a "continuous program of construction" that requires more than a few months to be completed. Therefore, it will be difficult for solar developers to "safe harbor" residential and commercial solar projects in 2019 and then actually finish those projects after 2020. This is in sharp contrast to what happened with respect to start-of-construction grandfathering for residential and commercial solar in the Treasury cash grant program.

Elimination of Inflation Adjustment. The proposed legislation would repeal the inflation adjustment for PTC calculations for renewable electricity production, thus reverting the PTC from the inflation-adjusted rate of 2.4 cents per kilowatt hour to its original rate of 1.5 cents per kilowatt hour.

The proposed change would apply to projects that began construction after the proposed legislation was enacted. The IRS presumably would use the actual continuous construction standard in determining when construction began. Therefore, projects that start construction after the legislation is enacted would be eligible for only 1.5 cents per kilowatt hour of renewable electricity production, rather than the inflation adjusted rate of 2.4 cents per kilowatt hour, over the 10-year PTC period. The 1.5 cents per kilowatt hour PTC would apply for the entire 10-year period, whereas under current law the inflation adjustment would apply to the PTC for the remaining years (i.e., the 2.4 cents per kilowatt hour rate would be adjusted for inflation in 2018).

The proposed legislation would not apply to existing wind projects that have been placed in service. Thus, for projects that are currently operating, the PTC would remain at 2.4 cents per kilowatt hour and would continue to adjust for inflation for the remaining years in the applicable PTC period.

The reduction of the amount of the PTC to 1.5 cents per kilowatt hour (before application of the phase-out rules) could have the effect of causing owners of new wind projects to opt for the ITC (in lieu of the PTC), because the elimination of the inflation adjustment does not impact the ITC. Generally, a stream of PTCs at 2.4 cent per kilowatt hour over 10 years (with an inflation adjustment) has been more attractive for land-based wind projects than a 30 percent ITC. However, a 30 percent ITC may be more attractive if the PTC rate is only 1.5 cents per kilowatt hour over 10 years (without an inflation adjustment). The start-of-construction phase-out for wind projects affects the PTC or, if elected, the ITC equally, so the phase-out should not change the dynamics of this decision.

Repeal of 10 Percent Permanent Solar ITC. The 2015 phase-out left in place the so-called "permanent" 10 percent solar ITC that applies to solar projects that begin construction after 2021 or are placed in service after 2023. The proposed legislation would repeal the 10 percent ITC for solar projects that begin construction after 2027.

Tax Credit Reinstated for "Orphaned" Technologies. The proposed legislation would reinstate the renewable energy tax credit for qualified fuel cells, geothermal, biomass, combined heat and power, landfill gas, small wind, solar illumination, incremental hydro and ocean energy projects. These technologies were, apparently inadvertently, excluded from the 2015 extension (with phase-out) for wind and solar.

Under the proposed legislation, qualified properties using these resources would be subject to the same requirements and phase-out percentages as qualified solar facilities.

For instance, the phase-out rate for qualified fuel cell plants would be 26 percent if their construction began after December 31, 2019, and before January 1, 2021. The phase-out rate would become 22 percent for qualified solar and fuel cell plants that began construction after December 31, 2020, and before January 1, 2022.

Expensing of Project Costs. The proposed legislation provides for "expensing" of all personal property (i.e., not real estate) through the end of 2022 to incentivize domestic investments, with an additional year for certain long-lived assets, including transmission.

The immediate expensing may incentivize sponsors looking to monetize investment tax credits to use sale-leasebacks, rather than partnership flip transactions.

Taxpayers would be able to opt out of "expensing" and into current MACRS (e.g., five-year double-declining balance depreciation) or straight-line depreciation. However, expensing would supersede the current 50 percent bonus depreciation rules, but there is a "transition rule" that would allow new taxpayers (e.g., a newly formed partnership) to elect use the "current" bonus deprecation rules (e.g., 50% bonus depreciation for wind and solar projects in 2017) on their first tax return. This transition rule effectively provides tax equity partnerships, which are generally new "taxpayers," to continue to use bonus depreciation (subject to the phase out under current law), instead of expensing, but there is a "transition rule" that would allow taxpayers to elect to use the "current" bonus deprecation rules (e.g., 50% bonus depreciation for wind and solar projects in 2017) on their first tax return filed for a tax year ending after September 27, 2017. This rule is not limited to new taxpayers, but an existing taxpayer can only use it on its 2017 tax return. In contrast, a taxpayer formed in 2018 (such as a new tax equity partnership), could also use the election to avoid "expensing" (and opt for bonus depreciation but at phased down 40% level) on its 2018 tax return which would be its first return filed after September 27, 2017.

Of particular note, the expensing appears to apply to "used" equipment that is "new" to the taxpayer. For instance, if a business purchases a truck manufactured in 2015 from a used car dealer, that truck would be eligible for expensing. This could incentivize owners of wind projects (including repowered projects) to sell them to an investor that could immediately expense the full cost of the project (other than real estate).

Electric Vehicles. The proposed legislation repeals the investment tax credit for electric vehicles starting in 2018.

Originally published November 4, 2017

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This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

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