US tax equity market could shrink with Senate bill | Norton Rose Fulbright
A base erosion and anti-abuse tax, called BEAT, in a massive tax-cut bill expected to be taken up next week by the US Senate could cause some tax equity investors to exit the market for renewable energy projects.
It could also claw back some tax credits claimed in 2018 or later years in tax equity transactions that already funded.
Both the Senate bill and a separate tax-cut bill that passed the House on November 16 have provisions aimed at preventing companies from reducing their US taxes by "stripping" earnings across the US border by making payments to foreign affiliates that can be deducted in the United States. An example is interest on intercompany debt or a payment to an affiliate in India for back-office services.
The Senate bill has a goal of ensuring that multinational companies do not use cross-border payments to reduce their US taxes to less than 10% of an expanded definition of taxable income.
However, the 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.
The Senate bill would require corporations to subtract B from A each year.
If B is less than A, then the US government would collect the entire gap as a tax.
A = 10% (12.5% after 2025) of the corporation's taxable income after adding back two amounts: deductible cross-border payments to affiliates and a percentage of any tax losses claimed that were carried from another year.
B = the corporation's regular tax liability reduced by all tax credits other than an R&D tax credit (and even by the R&D credit after 2025).
The problem for tax equity investors is that entering into tax equity deals has the potential to create a gap by reducing B.
This could disrupt the tax equity market because tax equity investors would be unable to determine at the start of a deal whether they will receive the tax credits the government is offering for investing in renewable energy. A calculation would have to be done every year at year end. An investor may find in years 3, 5 and 8 of a 10-year wind tax equity deal that the government will demand the tax credits for that year be paid to the US Treasury as a tax. Existing investments could also be affected.
Cross-border payments to affiliates are not added to A if the US collected a 30% withholding tax on the payment at the border. Many types of cross-border payments are subject to US withholding taxes, but the rates are often reduced due to tax treaties. A reduced rate means part of the cross-border payment would be added back.
The calculations would only have to be done by large companies.
Deductible cross-border payments must amount to at least 4% of a corporation's total deductions for the year for the corporation to be caught up in the provision. The corporation would also have to have average gross receipts over the prior three years of at least US$500 million. All related companies with more than 50% common ownership are treated as a single corporation for purposes of these tests.
The Senate is expected to take up the tax bill next week. The vote may be close. Republicans hold only a 52-to-48 majority. Five or six Republican Senators are undecided, and efforts to coax several Democrats to support the bill have so far not produced results. However, there is strong momentum behind it. Assuming it passes the Senate, the two houses will have to work out a common text. There is pressure on Republicans to wrap up everything before December 22, which is the earliest date on which any new Senator chosen in the Alabama special election could take office in case the Republicans lose a seat.
Tax equity accounts currently 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.