Unlocking the Power of Tax Equity: Empowering Renewable Energy for a Sustainable Future

There is broad acceptance in the scientific community that humans have negatively impacted the environment. However, the size of the impact and the effectiveness of our remediation efforts are hotly debated. The Chamber of Commerce estimates that $1 – $4 trillion of additional global investment is needed yearly for the next 25 years to put us on a more sustainable path.

That leads us to our question, do we proactively make massive investments today, or is human's resilient nature enough to ward off the worst case from occurring, requiring smaller incremental investments over time? The argument for both sides relies on differing opinions on the velocity of change that we are having on Earth's biosphere.

In this article, we will steer clear of the political debate and focus more squarely on the fact that fossil fuels are a limited resource and that there is an actual need to find alternative renewable energy sources. One of the most effective policies enacted in the U.S. is the tax credit program. Although effective, the tax equity partnership flip structure is arguably one of the most complicated and, at times, controversial in the U.S. project finance world. Today we'll try to shine a light on some of the basics.

Tax Equity Brief

To, reduce our dependency on fossil fuels while meeting the growing need for reliable, clean energy, the U.S. enacted tax policies that encourage investment by awarding beneficial tax treatment ("Tax Equity Benefits"). The tax code also gives developers a path to monetize the Tax Equity Benefits at the start of the project, providing them with the funds needed to finance these capital-intensive projects. This mechanism levels the playing field when considering the direct and societal costs of different types of energy generation projects; coal, natural gas, nuclear, wind, and solar.

Tax Benefits and Tax Credits

The amount of tax benefits and eligibility for collecting such benefits have changed over time; however, the three significant components persist (listed in % of total benefits):

• Renewable Energy Tax Credits – Dollar-for-dollar tax credits applied to the tax liability

  • The Inflation Reduction Act restored the ITC to 30% of project costs until 12/31/2032

• Benefits of accelerated depreciation (tax losses) – Allocation of net income losses

  • The value of the losses is largely dependent on the Tax Equity Partners' corporate tax rate

• Cash Allocation – Cash generated by the project

  • Limited during the early stages of the project (see table split below)

Types of Renewable Energy Tax Credits

Depending on the type of renewable energy, solar or wind, the amount and the timing of tax benefits can differ greatly. General Partners have the option of selecting one out of the two types of tax credits:

• Investment Tax Credits (“ITC”)

  • Eligibility: solar and wind - Most widely used on Solar and Offshore wind Projects

  • Calculated as % of the eligible costs of the project

  • Granted to the Equity partner at the commercial operation date (COD)

• Production Tax Credits (“PTC”)

  • Eligibility: wind only - Most widely used for On-Shore Wind Projects

  • Calculated as a $/kWh generation over the first 10 years of project operations

  • Granted to the Equity partner in the period of power generation

Sample Tax Equity Partnership Structure

A special purpose entity (SPE) or LLC is used when setting up a Tax Equity Partnership. Under this structure, the rights of the General Partner are transferred to the Tax Equity Investor, forming two classes of equity investors:

• Class A Equity investor (“Tax Equity Partner”) - Collects the majority of the tax benefits

• Class B Equity investor (“General Partner”) - Collects the majority of any project cash flow

Tax Equity can reach up to ~70% of project costs for wind and up to ~50% for solar.

The allocation of Tax Benefits between Tax Equity Partners can vary from deal to deal. However, each structure has two distinct stages, pre-flip and post-flip periods, signifying a change in ownership.

Other typical structural features

• Solar transactions flip after approximately 6 years and wind after 10 years

• The flip period is determined one of two ways, achieving an investor target IRR or a hard date

• A developer purchase option after the flip occurs to buy out the remaining TE Investor

• TE Investor performance contingent funding mechanism, pay-as-you-go (PAYGO Structure)

This insight was compiled in collaboration with our partners. Please consult your professional financial team to ensure your tax accounting and investment needs are satisfied.