Senate Tax Bill Threatens Market Innovation

tax equity loses ground

The Senate's version of the tax bill could 'claw-back' promised tax equity, creating uncertainty around the entire tax equity market.

tax equity revisionsThe Government does not have the resources to rebuild our aging infrastructure, let alone be responsible for innovating energy, water and transportation for a competitive future. That is a task that is currently going on through private investments supported by public policies. That takes on varying modes, from ‘green bonds’, to credits for utilities to use a higher portion of renewable energy and others. Such partnerships between government and private industry are an essential supporter of healthy markets in new technologies, going back to government bonds for US canal system and railroads,. Such projects cross the aisle, as some like the increased job opportunities while others take advantage of investment risk mitigated by public support.

In the renewable market an important driver for installing large, long term projects has been tax equity. Tax equity reduces tax liability when investing in solar or wind projects. According to Keith Martin, of Norton, Rose, Fulbright, tax equity currently accounts for 50% to 60% of the capital cost of a typical wind farm and 40% to 50% of the capital cost of a typical solar installation.

However, a key part of such equity is certainty. The tax equity investor needs to know that their future tax liability will be offset by the output of wind or the installation of solar. If the future is unclear, then the rationale for such investing is also unclear.

The current tax bill has created a complex formula that requires a company to compare their overall tax liability (minus any tax credits), to 10% of their taxable income, (including cross border deducible payments as well as a percentage of tax losses carried from another year).  An imbalance between that 10% of taxable income and what is owed would mean the US government would collect the entire gap as a tax. While one goal is to ensure that a company pays at least 10% in taxes, this formula muddies the waters for tax equity investors who will not know, from year to year, if they will get a credit or a bill for their investment.

As Mr. Martin commented in his article:

“[T]he way the tax is calculated could claw back tax credits that US companies were awarded for investing in renewable energy projects in the past. It would also make it harder for banks and other large companies that are the principal source of tax equity for renewable energy to know, when closing on tax equity investments, whether they will receive the tax credits on offer for making the investments. They would have to do a calculation at the end of each year to determine what tax credits they will be allowed to claim during the year.”

Renewables have advantages that make adoption irresistible: people as well as companies want control over their energy future. Large utility districts, seeing the writing on the wall, are changing business models to incorporate funding streams from energy efficiency adoption as well as the distributed energy from local customer’s solar and wind installations. As US companies enter the market, they are creating jobs that cross multiple skill levels. Already, more people are employed in California’s renewable energy industry than in traditional utilities.

This is an unstoppable trend, driven by market forces as well as concerns about air quality.  However, large scale adoption is primarily driven by private investment, in some cases supported by government incentives that pull in more private capital so that government does not have to bear the full burden of building a competitive infrastructure. In order to keep private dollars investing, uncertainty about the future impact of investments on taxes weakens the market.

Mr. Martin explains several ‘If and Buts’ in his article. However, if the goal of ‘tax reform’ is to make the tax code more transparent and simpler, this section of the proposed code is not achieving that goal.