On December 19 and 20, 2017, both the House and the Senate passed the “Tax Cuts and Jobs Act of 2017” (H.R. 1) (the “Tax Reform Act”), which is expected to be signed by the President. The House of Representatives had passed an earlier version of H.R. 1 (the “House Bill”) on November 16, 2017 by a vote of 227-206, and the Senate had passed its version of H.R. 1 (the “Senate Bill”) on December 2, 2017 by a vote of 51-49. During the week of December 4, 2017, the House of Representatives and the Senate formed the conference committee to reconcile the differences between the House Bill and the Senate Bill. The Tax Reform Act reflects, with minor changes not relevant to this discussion, the conference committee’s bill, released on December 15, 2017.
Prior to the release of the conference committee’s bill, the renewable energy industry was deeply concerned about proposals in both the House Bill and the Senate Bill that, if enacted, would have had significant negative effects on the utility of both renewable energy investment tax credits (“ITCs”) and energy production tax credits (“PTCs”). As enacted, the Tax Reform Act does not include a number of these proposals and has alleviated, on a temporary basis, the negative effect that the so-called “base erosion anti-abuse tax” (the “BEAT”) would have had on ITCs and PTCs.
As discussed in our prior client publication titled “House Republican Tax Reform Bill Retains and Modifies Energy Credits,” the overall direction of business tax reform, with lower rates and increased expensing, will have a significant impact on renewable energy investments going forward. The negative effect of tax reform on ITCs and PTCs, however, would have been greater under both the House Bill and the Senate Bill. As discussed below, the Tax Reform Act largely preserves the benefits of the ITCs and PTCs, at least in the short-term, but retains the Senate Bill’s BEAT (although with one important modification), which will create significant uncertainty for certain taxpayers considering tax equity investments.
The House Bill would have removed an inflation adjustment for PTCs, which would have significantly reduced their value, and modified the phase-out schedule for ITCs, the most significant change being the elimination of the permanent ITC for solar energy investment. The House Bill would also have clarified the determination of when a project begins construction, which would have resulted in the removal of the 5 percent investment safe harbor provided in current Internal Revenue Service guidance. The Tax Reform Act does not include these changes, and so the Tax Reform Act does not alter the current ITC and PTC regimes.
The Senate Bill, while not including the ITC and PTC changes in the House Bill, contained two provisions that could have had a chilling effect on investments in renewable energy products. For one, the Senate Bill retained the corporate alternative minimum tax (“AMT”), which would have affected many more corporate taxpayers given the lower overall corporate tax rates. Since the ITC cannot offset the corporate AMT, and the use of PTCs against the corporate AMT is subject to significant limitations, the retention of the corporate AMT may have reduced the utility of these credits. The Tax Reform Act, however, repeals the corporate AMT.
Second, and more significantly, the Senate Bill included the BEAT, which is a minimum tax designed to apply when U.S. taxpayers make payments to related foreign persons that are deductible against their U.S. taxable income. Under the Senate Bill, the BEAT applied where 10% of a taxpayer’s “modified taxable income” (which is the taxpayer’s taxable income after adding back certain deductible payments to foreign related parties) exceeds the taxpayer’s U.S. tax liability. The taxpayer’s regular tax liability was reduced by ITCs and PTCs, with the result being that the BEAT liability would recapture much of the benefit of ITCs and PTCs. Because a number of financial institutions that could be affected by the BEAT are also investors in renewable energy projects, this restriction seriously threatened future tax equity investments and created significant uncertainty for taxpayers currently considering such investments.
The Tax Reform Act revises the BEAT calculation in a manner designed to permit some use of a taxpayer’s ITCs and PTCs against the BEAT. Under the Tax Reform Act, a taxpayer’s tax liability for purposes of calculating the BEAT (for tax years beginning prior to January 1, 2026) is increased to add back 80% of the lesser of (i) a taxpayer’s available renewable energy ITCs and PTCs or (ii) the taxpayer’s BEAT liability without regard to this provision. By increasing the taxpayer’s tax liability in this manner, the taxpayer’s BEAT liability is correspondingly reduced. As a result, a portion of a taxpayer’s renewable energy ITCs and PTCs will reduce the taxpayer’s BEAT liability. This add-back sunsets in 2026, however. Even with this relief, the Tax Reform Act’s version of the BEAT will still have a negative impact on the utility of ITCs and PTCs. Because the relief provided in the Tax Reform Act is temporary, taxpayers will have to analyze the likelihood of extensions in considering the value of these credits. Furthermore, given that taxpayers may not be able to project their potential BEAT exposure in future years, there will be significant uncertainty regarding the value that tax equity investments will provide, particularly in the case of PTCs that are available over a ten-year period. Such uncertainty likely will have a negative impact on tax equity investment in the future.