Five days before Christmas 2017, the U.S. House of Representatives approved the final version of the first major overhaul of the nation’s tax system in 30 years. Two days later, U.S. President Donald Trump signed the bill, the first major legislative victory for a Republican Party that has controlled both houses of Congress and the presidency for a year.
In many ways the final bill represented a narrow miss for clean technology industries. Provisions to weaken the Production Tax Credit (PTC) for wind and eliminate the $7,500 federal tax credit for electric vehicles were removed in the final version. And through an 11th hour compromise, significant exemptions to the new Base Erosion Anti-abuse Tax (BEAT) were created for business tax credits, including the PTC and the Investment Tax Credit (ITC) for solar.
However, the BEAT provision is still in the bill, and will still have effects on the use of the ITC and the PTC, which are the two main federal supports for the solar and wind industries. This in turn will affect tax equity finance. And beyond this provision, tax reform will have implications for the profitability of renewable energy projects, these tax credits, and renewable energy finance in many different ways.
As this article is being written, the bill is still being studied and the full effects are not entirely clear. In fact, one of the few things that is clear is that these matters just got a lot more complicated.
Getting into the weeds on BEAT
The BEAT provision was created to prevent international companies from exempting too high a portion of U.S. earnings from federal taxes using tax credits, a process known as “stripping.” This was an important provision to help to make up for the very large tax cuts in the bill, including a reduction in the corporate tax rate to 21%.
Transactional lawyer Keith Martin of Norton Rose Fulbright was one of the first to raise the alarm about this provision in an article on his company’s site. Following a rapid mobilization in December by wind and solar trade groups, as well as certain members of Congress including wind-state Republicans, a provision was inserted into the final bill under which business tax credits including the ITC and the PTC can be used to offset up to 80% of the BEAT tax. However, the final bill also lowers the threshold that triggers application of the law to multinational companies from 4% of a company’s total deductions to 2% for financial institutions, and 3% for other companies.
Even in its modified form, BEAT will reduce the amount of tax equity that can be raised to finance wind and solar projects. Along the way it will make it more difficult for investors to calculate their returns from tax equity investments.
“(BEAT) could further reduce the amount of tax equity by making it harder for tax equity investors who are subject to the new tax to know, when a tax equity deal closes, whether they will receive the tax credits on which they are counting,” warns Martin in his piece on the Norton Rose Fulbright site. He explains that BEAT requires an annual calculation, and that tax equity investors will not know whether or not they will be able to monetize tax credits which they were counting on until the end of the year.
Bloomberg New Energy Finance (BNEF) senior analyst Nathan Serota has told pv magazine that the large multinational companies who will be most affected include both U.S.-based investment banks and overseas banks that provide tax equity in the U.S. BNEF also notes that this is likely to change how tax equity deals are structured.
And as tax equity becomes less available, this will inevitably lead to a shift in the way renewable energy projects are financed. Transactional lawyer Keith Martin estimates that tax equity currently makes up 40-50% of the capital stack for a typical utility-scale solar project, and several analysts have mentioned to pv magazine that they expect other forms of finance to fill the hole left by lower levels of tax equity, and particularly expect more debt.
Plus and minus
Not all the news in the Republican tax reform package is bad for renewable energy. While the BEAT provision will clearly have a negative impact on project finance, the reduction in the corporate tax rate to 21% will allow owners of wind and solar projects to keep a larger portion of the profits from electricity sales. But while the overall profitability of wind and solar projects will benefit from the lower corporate tax rate, the depreciation of these assets will be worth less at the lower rate.
These are far from the only changes in the tax bill that will affect renewable energy expensing. The bill allows for project owners – except regulated utilities – to write off the full cost of equipment in the year it is installed. It also limits deductions for interest paid, with Guggenheim Securities noting that this could affect some highly leveraged companies, particularly yieldcos, but says that with other tax shields available it does not expect “material impact” at this time.
In his article on the Norton Rose Fulbright site, Keith Martin mentions 10 other distinct ways in which the tax bill could affect the project finance market, and as such it is inherently difficult to analyze the net effect of all these changes.
Republicans and renewables
Beyond the technicalities of the changes to the tax code, the process of crafting the tax reform bill speaks to the relationship of the U.S. Republican Party to renewable energy industries. In particular, Congressional Republican leadership was convinced to not only preserve the tax benefits enjoyed by wind and electric vehicles (EVs), but also to soften the impact of the BEAT provision. Winning such a concession is a testament to the growing economic and political clout of renewables, particularly wind.
Some of this is related to geography. It is no accident that many of the legislators who were listed as allies by groups like the American Council On Renewable Energy (ACORE) and who signed a letter calling on the conference committee to not damage wind tax credits or their monetization came mostly from Midwestern and Plains states, where the wind industry is strong and a significant employer.
However, the process also reveals that even some of the biggest Republican champions of renewable energy are willing to risk damaging these industries to achieve other policy objectives. Senator Chuck Grassley (R-IA) has been an outspoken champion of wind and the PTC in the Senate, yet still helped to push forward a version of the tax reform bill containing the BEAT provision through the Senate Finance Committee. This included joining a party-line vote to stop a Democratic amendment that would have exempted the ITC and PTC from the provision.
At the end of the day, the tax bill does not provide any new benefits for renewable energy, and it does weaken tax equity finance and the monetization of both the ITC and PTC. Thus, even if Congressional Republicans did not set out with this bill to specifically damage wind and solar, the party appears to be remarkably willing to inflict collateral damage on renewable energy.
This is in sharp contrast to Congressional Democrats, who have repeatedly pushed for higher levels of policy support for solar and wind. And if neutrality towards existing tax credits is the best we can expect from the Republican Party, then this contrasts sharply with the oft-repeated line from the Solar Energy Industries Association (SEIA) that solar has friends “on both sides of the aisle.” In fact, it demonstrates clearly that such “friends” are at best a minor element within a party that could throw wind and solar under the bus at any time.
Assessing the overall impact
The overall impact of the tax reform bill is inherently hard to assess, and opinions may vary among analysts. In its Alternative Energy Weekly, Guggenheim Securities described tax reform as a “non-event” for the clean technology and alternative energy spaces, and predicted “business as usual.” BNEF’s Nathan Serota has taken a more cautious line, noting that it will be necessary to see how the largest tax equity providers respond before we know the full impact to the downstream market. But even if there is little or no change to overall market volumes, profitability, or other metrics, the details of renewable energy finance will change under the new rules. This includes both changes to the way that tax equity deals are structured and a decrease in the portion of tax equity in capital stacks along with an increase in the use of debt as an instrument.
Additionally, tax reform showed the renewable energy industries flexing their political muscles and winning concessions from the Republican Party, despite many pressures including a rapid and secretive process towards approval.
Either way, the final tax bill is not expected to bring about the “devastation” that was warned of when the BEAT provision was first discovered, and is not the most potent threat to the U.S. solar market. Instead, the gravest danger over the next 18 months comes from the tariffs, quotas, and any other trade actions expected from the Trump Administration, the final form of which will be revealed some time this month.