What Is a Tax Equity Investment

Last week, Engie North America announced what it called the largest tax-sharing agreement of its kind in the United States – 2 gigawatts of renewable energy, including 1.5 GW of wind power and 500 megawatts of solar power, funded by $1.6 billion in tax-sharing obligations from Bank of America and HSBC. Developer Capital Responsible for development costs, mortgage guarantees, and any project costs not provided by tax capital investors or lenders (typically, debt is incurred outside the project company and interferes with access to project cash flows after tax justice) policies can also affect demand for tax equity. For example, as tax incentives for renewables gradually decrease, renewable energy investors may have fewer tax credits to monetize. A weaker demand for tax fairness could tend to reduce the cost of financing tax equity from the perspective of investors in targeted activities and reduce the total return for tax equity investors. Tax justice: Between 40% and 60% of the project costs are covered by investors in exchange for tax credits and cash returns These tax credits and income deductions are only useful for parties that owe income tax. Promoters are often structured as a business, which means they are not eligible to take advantage of certain tax credits or depreciation benefits. As a result, developers partner with investors in tax stocks. An example of this would be a partnership reversal that subsidizes a wide range of activities through tax laws. The majority of available tax incentives are used directly by the party involved in the activity sought by the grant. However, there are several tax credits that often require or encourage the intended recipient of the grant to work with a third party to take advantage of the tax incentive. This can happen because the tax credits are non-refundable and the intended beneficiary of the tax credit has little or no tax payable (p.B a non-profit organization), or because the credits are granted over several years, when pre-financing is required to start the work. This situation often leads to a tax participation transaction – the intended beneficiary of the tax credit agrees to transfer the rights to claim the credits to a third party in exchange for an equity financing contribution. According to one estimate, the size of the tax capital market would be $20 billion in 2017.1 Tax credits could be replaced by subsidies.

One of the problems with the current tax justice mechanism is the amount of subsidies diverted from the underlying activity to third-party investors and intermediaries. Even if the tax credits were fully refundable, as discussed above, tax justice could still be used to monetize the tax credits to obtain pre-financing. Not-for-profit organizations that do not file federal tax returns would generally not directly benefit from an incentive under tax legislation. Another problem with the current tax fairness structure, which has already been mentioned, is that it can potentially lead to a distortion of large projects due to investors` appetite for tax credits combined with cost savings from assessing and tracking fewer projects.55 Capital tax credits for renewable energy date back to the late 1970s.29 The Renewable Energy Generation Tax Credit (TCO) was enacted into the Energy Policy Act of 1992 (P.L. 102-486).30 In recent years, the cost of these two incentives has increased as investment in renewable energy technologies has accelerated. For fiscal year 2018, the YCW estimates the Tax Expenditures for the Renewable Energy Investment (ITA) Tax Credit at $2.8 billion.31 The estimated tax expenditures for the TPC for fiscal 2018 are $5.1 billion. Solar energy accounts for the majority of itC revenue losses ($2.5 billion of the $2.8 billion for all eligible technologies).32 In the case of the TPC, the majority of lost revenue is associated with tax credits claimed for the use of wind energy to generate electricity ($4.7 billion of the $5.1 billion for all eligible technologies).33 Paul Schwabe, David Feldman, Jason Fields and Edward Settle, Wind Energy Finance in the United States: Current Practice and Opportunities, National Renewable Energy Laboratory, NREL/TP-6A20-68227, August 2017; and Emma Foehringer Merchant, “Renewables Tax Equity Market Fares Fine in Q1, Calming Industry Fears,” Greentech Media, May 17, 2018, www.greentechmedia.com/articles/read/renewables-tax-equity-market-fares-fine-in-q1. In the case of the LIHTC, the grants were awarded through the competitive credit process.

The need to intervene in tax credit markets underscores that the tax fairness mechanism may result in fluctuations in subsidies receiving eligible activities, as outlined in the “Subsidy Fluctuations” section. All of these federal tax incentives and the project`s cash flows over the life of the investment are available to the solar tax equity investor who invests in the solar project. Many energy-generating assets, from solar to wind, are financed by a form of investment called tax justice. Here`s how tax equity financing comes into play, both from an investment and project management perspective. Investors in tax stocks would be willing to pay more if loans were accelerated for two reasons. First, a shorter eligibility period means that investors would reduce the discount on the total flow of tax credits because they could settle their tax obligations earlier. Second, longer claim periods lead to more uncertainty (risk) as to whether an investor has a sufficient tax obligation to use the purchased loans. Accelerating the tax credit reduces this risk, and lower risk would ensure that current investors would be willing to pay higher prices for tax credits. Less risk could also bring new investors in tax stocks to the market, which would also tend to raise tax credit prices.

Investors in tax stocks can also benefit from tax benefits that are not credits, such as accelerated .B or bonus depreciation or tax losses. While this report tends to refer to tax credits when describing tax participation transactions, further tax savings can be achieved. Tax justice is an important source of capital for solar projects, but many developers do not have enough taxable income to take advantage of the federal government`s available tax incentives themselves. In addition, tax capital is generally cheaper than other sources of capital when measured in pre-tax cash – an important measure for most developers. Insurance is a necessary part of any solar system plan. Solar projects must be well insured. A tax investor`s return depends on the price paid per loan and the associated benefits the investor receives in return. In the simplest case, the only benefit the investor derives from the credits is the ability to reduce his tax payable. For example, imagine a project that will cost $1.5 million to complete and generate $1 million in federal tax credits that its owner wants to sell to finance the initial costs of the project. An external investor agreed to pay 90 cents of equity financing in exchange for each $1.00 tax credit. Thus, the investor pays (enters in capital) $ 900,000 in exchange for $ 1 million in tax credits. The net return to the investor is $100,000 (in reduced taxes) or 11.1% ($100,000 divided by $900,000).11 Eliminating the need to form a partnership to invest in tax-sharing projects could expand the pool of potential investors.

This, in turn, could improve competition for tax credits, which could lead to an increase in equity per dollar of federal tax revenue lost. However, it is not clear what the impact of transferring credits directly to transactions with other tax benefits, often bundled with tax credits, would be. For example, the section titled “The Tax Equity Investor`s Return” states that investors can also obtain a claim from other state and federal tax incentives, operating income and loss, capital gains on the sale of the underlying investment, or goodwill from the community or regulators. Accelerating credit could potentially reduce the cost of tax justice. However, this option would not eliminate the need to rely on tax stock markets. In addition, this option applies more directly to tax credits or other tax benefits that occur over a period of several years and reduce the tax payable, as opposed to the current taxation year. Consideration of various options could determine whether the use of tax stock markets is an efficient and effective means of providing financial support to the federal government. At first glance, it may seem that the government would get more “for its money” if it gave subsidies more directly, with no role for tax stock markets.

However, such a conclusion overlooks a role that tax equity investors play in certain industries in addition to providing financing: they assess the quality of projects before investment and provide ongoing monitoring and compliance monitoring. In fact, the tax justice mechanism outsources some of the monitoring and surveillance of compliance to investors to generate a financial return. On the one hand, it can be useful for the federal government to be able to rely on external investors for oversight and oversight. On the other hand, some tax participation programs, where a government agency oversees compliance with participants` regulations, may eliminate the supervisory role of investors. There may also be ways to improve the current approach to deployment. .