When Subsidies Reduce Tax Credits in Renewable Energy Projects | Norton Rose Fulbright
You have learned that your energy project will benefit from state or local financial incentives. Now you need to know whether these state or local grants, rebates or other subsidies will reduce the amount of federal tax credits that may be claimed on the project.
The answer depends on the characteristics of the state or local program. This article describes the existing guidance on the subject.
PTCs and ITCs
Federal production tax credits are available to taxpayers owning (and in the case of some biomass projects, leasing) power plants that generate electricity from certain renewable sources: wind, biomass, geothermal steam or fluid, landfill gas, garbage or water. This year PTCs are either 1¢ or 1.9¢ per kilowatt hour of electricity generated, depending on the type of renewable source.
The statute granting PTCs provides that available federal credits will be reduced, by as much as 50%, to the extent that the project benefits from federal, state or local grants, tax-exempt financing, subsidized energy financing or “other credits.” The IRS said in February that the term “other credits” in the PTC statute means only federal credits, not state or local tax credits. However, we still need to analyze whether state and local tax credits are “grants” that reduce PTCs.
Federal investment tax credits are available for solar energy projects (and geothermal projects on which the owner chooses to forego production tax credits) . ITCs for solar projects are 30% (10% after 2007). They are that percentage of the cost of new equipment that uses solar energy to generate electricity, heat or cool or provide hot water for use in a struc- ture, or provide solar process heat. There are also ITCs of 20% of the cost of certain new equipment to gasify biomass, although these credits are subject to a nationwide cap and must be allocated to the taxpayer by the IRS. The statute granting ITCs reduces the federal credits by the full amount of tax-exempt financing and subsidized energy financing that helped to pay for the assets. Grants are potentially subsidized energy financing for this purpose unless the recipient reports the grant as taxable income.
The PTC statute requires tax credits to be reduced by the amount of grants benefiting the project.
State or local grants and rebates do not reduce the basis of energy property on which the ITCs are calculated, as long as the grant or rebate is included in the federal gross income of the recipient.
Most state and local grants and rebates should be included in gross income for federal purposes, so they should not ordinarily reduce ITC basis. The IRS said in a 1979 revenue ruling that a state grant to fund the cost of a solar hot water heater was included in federal gross income and did not reduce the taxpayer’s basis in the property for purposes of claiming the federal tax credit. A 1980 private letter ruling holds that Wisconsin refund- able income tax credits for installing alternative energy systems that the IRS said were equivalent to grants did not reduce the basis of property for federal tax credit purposes on the same grounds that the value had to be reported as income.
However, rebates from a utility to a customer to help pay for energy conservation measures in a dwelling unit do not have to be reported as income under a special section of the US tax code. These “energy efficiency” rebates, because they are tax exempt, do reduce ITC basis in a solar project.
It is fairly clear that state and local grants and rebates (other than energy-efficiency rebates) benefiting an individual taxpayer who is not receiving the amount in connection with his business are included in federal gross income. It is not as clear that grants and rebates benefiting a business must always be included in federal gross income. However, businesses will derive a greater tax benefit if they include the grants in gross income and preserve the basis of property on which the ITC can be claimed.
Are all cash payments “grants”? No. The IRS said in a 2003 private letter ruling issued to a wind farm claiming PTCs that an operating subsidy paid by the state was not a “grant” because the wind farm would have to repay the money if it did not spend it on operating costs within a certain period of time. The IRS suggested that funds are a “grant” only if there are no circumstances in which they will have to be repaid. The IRS has also confirmed, in a 2002 private letter ruling about a wind project, that privately-funded grants do not reduce PTCs.
Renewable energy credits or other environmental attributes created and granted under law are not “grants.” The IRS issued a private letter ruling in 2001 stating that PTCs accruing to a wind farm were not reduced due to receipt of state RECs.
Even if it is clear that a state or local benefit is not a “grant” that reduces federal tax credits, that benefit should also be analyzed to determine if it is “subsidized energy financing.”
Otherwise available PTCs are reduced, by as much as 50%, to the extent that the project benefits from tax-exempt financing. The basis of property eligible for ITCs is reduced by the full amount of tax-exempt financing that is lent to the project.
State and local governments can issue tax-exempt bonds for public facilities and for certain private projects, listed in the tax code, that are considered to have public benefits. In tax-exempt financing for private projects, the state or local government issues the bonds and relends the proceeds to the project.
The entire amount of the financing is counted in figuring the reduction in PTCs or ITCs, not merely the value to the taxpayer of the reduced interest rate. In the case of ITCs, for example, if the project cost is $100 million and $60 million in bond proceeds are lent to the project, only $40 million in creditable basis remains. In the case of PTCs, if a tax credit of 1¢ per kWh would otherwise be available on a project that cost $100 million, and there is tax-exempt financing of $60 million, the PTCs are reduced by the full 50% permitted in the PTC statute (to 0.5¢ per KWh).
Subsidized Energy Financing
Even if you are certain that your state or local financial benefit is not a grant or the proceeds of tax-exempt bonds, you need to consider whether the benefit is “subsidized energy financing” that also reduces PTCs and ITCs.
Subsidized energy financing is defined as financing under a federal, state or local program with a principal purpose of providing subsidized financing for projects designed to conserve or produce energy. The following discussion assumes that the government program has such a focus.
It is subsidized energy financing if a government agency makes a direct loan to an energy project at a below-market rate. Proposed energy credit regulations state that funds are sourced to a government if the funds are provided directly or indirectly by a government agency, including through an intermediary that is a bank or other lender.
It is also subsidized energy financing if a government pays a bank that is lending to a project in order to compensate the bank for providing a lower interest rate on the loan than the bank would ordinary use. In this case, the entire amount of the financing to the project will reduce tax credit basis - not just the amount paid by the government to the bank. In regulations issued under a now-repealed tax code section that also used the term “subsidized energy financing,” the IRS provided an example of a bank lending $3,000 to a homeowner to install a solar water heater where the bank reduced the principal amount to $2,500 upon receipt of $500 from a federal conservation program. The amount of subsidized energy financing that reduced the homeowner’s tax credit basis is $3,000, not just the $500. Another example in these regulations shows that “subsidized energy financing” includes low-interest financing from a bank under a state program that compensates the bank with state tax credits for making low-interest financing available to energy projects. Again, the entire amount of the financing reduces the taxpayer’s ITC basis in property, not just the value of the state tax credits claimed by the bank.
A loan guarantee from a federal or state agency or utility is not subsidized energy financing. Thus, if a project benefits from a loan guarantee, the amount guaranteed should not ordinarily reduce PTCs or ITCs even though the interest rate on the loan is lower than it would have been without the guarantee.
Privately funded payments should not be considered subsidized energy financing. In a 2002 private letter ruling, the IRS held that wind incentive payments that were both funded and administered by private parties (a private utility and a charity, respectively) were not subsidized energy financing. In that ruling, the incentive payments were based on the kilowatt hours of energy generated and did not pay down capital costs of the project.
If a public utility is required to provide low-interest loans to businesses for the purchase of energy property and the public utility funds this financing by imposing a surcharge on its customers for utility service, the financing is not treated as subsidized energy financing. It does not matter that the utility is required by state law to offer the loans. They are privately funded. However, if the public utility funds its financing program with money received from a state or local government, the financing is subsidized energy financing. The IRS ruled privately in 2004 that an advance payment received by a wind project from a tax-exempt trust was not subsidized energy financing where the trust was prepaying for the environmental attributes of the energy; the trust was funded by a charge imposed on public utility customers under a state program to promote renewable energy.
The IRS has ruled that it is not subsidized energy financing when an investor-owned utility provides rebates on electricity bills to homeowners who install solar hot water heaters. This is because the money used to fund the program comes from the private sources. Neither is it subsidized energy financing when a federal utility makes loans at below- market interest rates to customers of local utilities to which the federal utility provides power. Since by law federal utilities must cover all costs from their own revenues, the cost of the below-market loan program does not fall on the federal government.
The IRS has ruled several times that direct operating subsidies paid by state or local governments to solar producers are not subsidized energy financing. Operating subsidies do not reduce PTCs; only help with the capital costs of a project is potentially a problem.