View a recording of our introductory webinar from September 28th! View

Corporate Actions Playbook

The following represents an initial release of the ZEROgrid Playbook, a living document that will be expanded and revised over time to reflect new insights.

IRA Tax Credit Transfer Market

Context: Why is it important to companies?    

In addition to providing significant financial incentives for carbon-free energy deployment through expanded and extended tax credits, the Inflation Reduction Act (IRA) created a mechanism to transfer certain tax credits, opening a new pathway for companies to support resource deployment. 

Prior to the IRA, renewable energy owners — such as independent power producers (IPPs) and investor-owned utilities (IOUs) — faced barriers to efficient monetization of investment and production tax credits (ITCs and PTCs). If these entities had sufficient taxable income (tax appetite), they could reduce their own tax burdens (i.e., self-monetize the tax credits) as the tax credits were realized. However, this was only rarely the case because most IPPs and IOUs lacked tax appetite to efficiently monetize the tax credits (i.e., without the need for carrying them forward), especially for solar projects that were restricted to ITCs with their front-loaded tax benefit.  

IPPs and IOUs could get help from external parties, at a hefty cost 

The common approach for IPPs to tackle this problem was to rely on tax equity investors to provide a portion of the up-front financing to the project. These tax equity investors took on partial ownership of the assets (via an equity investment) and received the majority of the tax credits and other tax benefits (i.e., accelerated depreciation) in return. These complex tax equity transactions were — and still are — handled by a limited number of firms (chiefly large financial institutions) that demand a large premium in exchange for making their tax capacity available.  

Historically, just a handful of IOUs with tax capacity have built and owned renewable assets. In principle, IOUs without tax capacity could create regulatory assets, charging customers a carrying charge for tax credits until they could be monetized. However, this effectively increased ratepayer costs, making this option relatively unattractive and uncommon. While tax equity has also been used on a couple of occasions by IOUs, the significant associated reduction in earnings to utility shareholders from the use of third-party equity has generally made its use unattractive more broadly.  

Complicating matters, regulated utilities were required to “normalize” the ITC over the life of the underlying asset, which restricted the pace at which the value of these tax credits could be passed through to customers, essentially increasing the cost of utility-owned ITC assets from the customer perspective. For solar and associated battery storage, the PTC was not an available option. This made it difficult for utility-owned solar and storage to compete on cost with IPP-owned assets (purely because of tax law) and reduced the incentive of these companies to transition to clean energy. 

The IRA has changed federal clean energy tax credit in two fundamental ways: 

  1. Tax Credit Expansion: Carbon-free electricity tax credits in the past were essentially limited to the ITC for solar and associated storage, the PTC and ITC for wind, and a production-type credit for carbon capture.1 The IRA portfolio of credits is much broader: the legislation created tax credits for manufacturers involved in hydrogen production and battery production, the PTC was extended to cover solar, and stand-alone storage was made eligible for the ITC with a provision for regulated utilities to opt-out of normalization. In addition, the value of the wind, solar, storage, and carbon capture credits was raised significantly compared with pre-IRA levels (in the cases of wind, solar, and storage through the creation of bonus provisions for using specified amounts of domestic content and/or locating in energy communities identified by their economic and physical connections to the fossil energy economy). 
  1. Transferability and Elective Pay: The IRA allows these tax credits to be transferred between parties, thereby providing an alternative to traditional tax equity structures — contractually far simpler and not requiring a long-term equity investment in the tax incentivized project by the party making its tax capacity available. For governments, tax-exempt entities, and rural electric cooperatives, tax credits are now cash refundable through a process known as elective pay. For all types of asset owners, certain assets, including hydrogen and carbon capture facilities, are eligible for elective pay for a portion of their tax credit benefits. 

These IRA changes significantly lower barriers to corporate participation in the clean energy transition. Tax credit transfer is compatible with tax equity partnerships, so large corporate buyers that previously were involved in the tax equity market still have the option to retain project ownership and consider a hybrid solution with tax credit transfer. By participating in this market, companies can enable multiple potential benefits, such as: 

  • Reducing their own tax burdens: Corporate buyers can use the tax credits to reduce their federal income taxes. For large companies affected by the 15% corporate alternative minimum tax (CAMT), the PTC and ITC may be used to offset up to 75% of the minimum tax. 
  • Accelerating clean technology deployment by providing financing support: Corporate buyers can provide financing support to clean energy projects by purchasing tax credits and providing additional sources of financing. This is especially critical for technologies that are currently less commercially viable. Corporate buyers may be able to claim to have meaningfully contributed to clean energy deployment by supporting these projects. 
  • Supporting energy justice: By purchasing tax credits and lowering the cost of capital for developers, corporate buyers help lower project costs. Projects that provide energy supply to utility and local community customers will help reduce the overall rate base and customer bill impact. This is particularly critical in areas where low- and moderate-income groups also face high energy burden.  

Challenges: What obstacles should companies expect to encounter?    

Lack of internal understanding: Even though tax transferability is significantly simpler than traditional tax equity partnerships, the transferable tax credit market and associated transactions are nascent, and corporate teams will need to build internal understanding around the possible financial structures, their benefits, and their limitations.  

Headline risks: Despite the potential for corporate involvement to expedite clean energy adoption and support energy equity via tax credit transfer transactions, companies need to be cautious in their messaging. It is crucial to communicate these initiatives thoughtfully to avoid potential misperceptions. There is concern that the public might view these transactions as prioritizing corporate gains over broader societal benefits, even though these transactions would ultimately create a “win-win” for companies and surrounding communities thanks to the federal incentives. 

Financial risks: Even though tax credit transfer transactions can provide financial benefits by reducing a corporation’s tax burden, there are risks associated with this approach. For example, companies may not be able to utilize anticipated credits as anticipated if the projects do not pass certain eligibility requirements (seller indemnification commitments/tax credit insurance will be integral deal components) or if a company’s tax appetite ends up being lower than expected. 

Ambiguity around the green attributes: Traditional tax equity partnership deals have not automatically included green attributes (e.g., RECs), and as such companies should not assume that tax credits purchased via transferability will necessarily provide any Scope 2 benefits. In the absence of RECs, it can be difficult for companies to make a firm and quantifiable claim about their support to clean energy development, especially if multiple companies are involved in the tax credit transfer transaction.  

Solutions: What should companies do?  

Policy and Engagement Actions: 

  • Engage in further policy conversations: Companies can engage with policymakers for regulations that yield a more robust tax credit transfer market, for instance by advocating for individual taxpayers to be allowed to participate — a move that might mitigate suggestions of corporate privilege as well as increase demand for (and prices of) transferred credits. 

Procurement and Finance Actions: 

  • Partner with experts to better understand the opportunities and risks: Financial institutions and tax advisors can help companies understand the landscape of the tax transfer market and evaluate options; the risk profiles of different types of transactions will vary based on several important factors (e.g., PTC or ITC, different technology choices, the contract duration). 
  • Partner with experts to explore options with enhanced green attribute claims: Companies can partner with REC experts to design customized transactions. One option could be a bundled REC and tax credit purchase or redesigned “tiered” REC instruments. Tax credit purchases could also be incorporated into green tariffs to further buttress green attribute claims by companies with clean energy procurement programs. 

RMI is working with these experts to develop educational materials to facilitate the creation of the tax transfer market. If companies are interested in learning more about the market participants or RMI effort, feel free to reach out to us through the “Contact Us” link on the ZEROgrid website. 

Resources