Tax Reform and the Solar Industry: What's the BEAT?
With December 31, 2017 quickly approaching and an end to President Trump’s first year in office, the President, alongside House and Senate Republicans, is looking to make good on a campaign-trail promise of tax reform. Back in November, the House passed the Tax Cuts and Jobs Act and was soon followed by the Senate, which passed its bill at the beginning of December. Now that both houses have passed their respective bills, each with their own edits, the solar industry is taking a deeper look at the provisions and beginning to dig into potential industry impacts. As such, we would be remiss if we didn’t cover what we’re seeing and hearing in regards to tax reform and its potential effects.
Reduction in Tax Equity Investments
The most obvious of the solar industry’s negative exposure to tax reform is the reduction of the corporate tax rate. Both House and Senate versions of the bill reduce the corporate tax rate to 21 percent. This lower corporate tax rate would decrease tax liability for entities like banks and insurance companies, resulting in a smaller tax liability to offset through solar’s 30 percent federal investment tax credit (ITC). This would shrink the total pool of potential solar investors and capital to be deployed for projects. Equally important, a reduction in the effective tax rate substantially reduces the value of depreciation, which offsets income (not tax liability).
While tax appetite will likely shrink under a lower corporate tax rate, the potential removal of other tax credits from the tax code may push those investors still looking to leverage tax credit investments toward solar. While the Low-Income Housing Tax credit is preserved in both bills, albeit with some modifications to the bond markets, other prevalent tax credits like the Historic Tax Credit (HTC), or even our dear cousin wind’s Production Tax Credit (PTC) are facing tax reform threats.
For both the HTC and the PTC, what’s in store for them is largely dependent on what outlasts the reconciliation process currently underway and rapidly finishing. The HTC is repealed in the House bill but faces minimal changes in the Senate bill, where the credits now have to be claimed over 5 years rather than when placed in service (which is how the law stands currently). However, even the slight changes in the Senate version make the HTC less attractive to a solar ITC investment that can be claimed all at once rather than over five years. So, either way, challenges in both bills to the HTC could push investments towards solar.
For the PTC, how reconciliation shakes out in regard to the Alternative Minimum Tax (AMT) will impact its future attractiveness. Under both House and Senate bills, the corporate tax rate is taken down to 20 percent; this reduction in the corporate tax rate takes companies down to the level of the AMT. This is potentially problematic for the PTC, as only four years of wind production credits are eligible to be claimed for companies at the level of the AMT, as opposed to the normal 10 years when above the AMT.
The full ITC is still eligible to claimed against the AMT though making it more competitive in a scenario where the AMT is retained. The House bill removes the AMT thus letting the PTC stay at its full 10 years, but the Senate bill retains it and essentially shortens the PTC to only four years. How reconciliation handles the AMT will affect the attractiveness of the PTC as a corporate tax investment strategy, and thus the comparative attractiveness of solar’s ITC.
A reduced tax rate will certainly affect the outcome of tax credits and which credits, if any, investors choose to leverage. However, one silver lining is reduced tax rates could mean fewer taxes on solar project owners’ income generated from their projects.
In addition to traditional threats of lower tax rates, the newest threat to tax equity investment in solar appeared in the Senate version of the bill with the introduction of the base erosion and anti-abuse tax (BEAT). The BEAT targets companies that seek to reduce their tax liability through cross-border payments to affiliates and comes into effect when those investments reduce a company’s U.S. tax liability to less than 10 percent of taxable income. Under the BEAT, PTC and ITC investments cannot reduce tax liability below this minimum 10% threshold. For companies that have cross border payments and are near this 10% threshold, tax equity investments in both wind and solar will be less attractive.
However, the BEAT mainly targets larger multinational corporations making payments to foreign affiliates or foreign corporations with U.S. business. These categories of investors, while a small portion of tax equity investments, are by no means the sole investors, and other potential investors can still place their investments without concern for the BEAT. Additionally, while the Senate bill introduced the BEAT, it is not present in the House bill, and therefore could potentially be removed through the reconciliation process.
Negative Impacts on Bonds
While threats to corporation’s tax liability are the most obvious dangers of tax reform, there are others lurking in the hundreds of pages that have the ability to deter future solar growth. One big one is the potential repeal of the tax-exempt status of private activity bonds (PAB) in the House version of the bill.
Hopefully this doesn’t come to pass, but if it does, for municipal players looking to get involved in clean energy, it could change the cost of issuing debt to help finance projects for the worse. Municipal utilities represent a market that was recently opened to solar and has been expanding. According to GTMs Q3 2017 US Solar Market Insight report, the Midwest could experience 55% compound annual growth rate between 2017 and 2022 largely driven by investor owned utilities alongside their smaller cooperative and municipal utility partners. However, the future of tax-exempt status of bonds could change this outcome, as debt would become more expensive.
Others, in the MUSH (munis, universities, schools, and hospitals) universe that have been solar customer targets for years will also be affected, and this could shrink potential solar customer pools. Reconciliation could change this outcome, as the Senate version does not repeal the tax-exempt status of PABs. External pressures are urging House GOP members towards this outcome which would help preserve solar project funding alongside funding for many other socially beneficial projects.
Tax reform currently poses more questions than answers. House and Senate Republicans are frantically working through the reconciliation process and are hoping to get the bill on the President’s desk as soon as possible, especially before Senator-Elect Doug Jones (D-AL) gets into his seat, making the potential for party defectors on the bill more tenuous. Ultimately, how solar is affected will largely be dependent on this reconciliation process, and the industry should pay close attention to these key issues.
As this is being written, all of this could change, so for up-to-date news on how tax reform could affect your potential investments reach out to: Jessica.firstname.lastname@example.org.
This is an excerpt from the December 2017 edition of The SOL SOURCE, a monthly electronic newsletter analyzing the latest trends in renewable energy based on our unique position in the solar financing space. To receive future editions of the journal, please subscribe.
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