The new tax law’s corporate-friendly changes welcomed by most businesses have left investors and brokers involved in the tax credit financing industry spinning.
Not all tax credits are affected equally. Structural changes to the federal historic rehabilitation tax credit included in the Tax Cuts and Jobs Act (P.L. 115-97) have put that market on pause, and investors in the renewable energy incentives market, including credits for solar and wind, are still grappling with how the corporate base erosion and antiabuse tax (BEAT) will play out.
“One of our observations over the years is that the only constant in our marketplace is constant change,” said Jack Cargas, Bank of America Merrill Lynch’s managing director of renewable energy finance. “There has been such a significant change in the marketplace that we’re in a moment of reset,” he added.
Investors in the tax equity industry take many forms, but essentially follow the same formula: Developers of projects eligible for federal tax credits, ranging from renewable energy to low-income housing to historic rehabilitation, are able to attract investors with the promise of tax credits that can offset the investors’ own tax liability.
“I don’t think deals aren’t going to get done, but what we do expect is . . . there’s going to be less demand,” said Darryl P. Jacobs of Ginsberg Jacobs LLC, a specialist in tax credit financing transactions.
According to Jacobs, demand for tax credits had generally been very high, with new markets tax credits, for example, selling at 84 to 87 cents per dollar of credit. With demand dropping, that means downward pressure on tax credit pricing, he said.
Meanwhile, Jeff Jacobson, president of Clocktower Tax Credits LLC, said it was too soon to predict how the market would play out. There has been a pause in the market in response to the TCJA, he acknowledged, partly a result of tax departments doing routine year-end analyses, but also because they now have to calculate the tax law’s impact on their business plans.
Some of that hesitancy in the market is because “people are afraid to be the first one out there to price [credits],” Jacobson surmised.
Jacobson downplayed the impact of the corporate income tax rate reduction. Although the TCJA’s corporate rate cut from 35 percent to 21 percent might suggest a commensurate 40 percent reduction in tax liability that can be offset by credits, companies are “only buying a fraction of what they potentially could buy,” he said.
However, John Eber, manager director of energy investments for J.P. Morgan, said on a January 11 webinar hosted by Norton Rose Fulbright that the corporate rate reduction by itself amounts to a “substantial drop in overall [tax] capacity,” which is further affected by a roughly 75 percent limitation on the amount of tax credits that corporations can claim against their liability.
BEAT Down but Not Out
A more likely source of disruption in the market is the BEAT, which “uses new metrics that people hadn’t even measured before,” Jacobson said. That tax has the potential to “knock out the huge international buyers [of credits], the Citibanks, the JPMorgan Chases,” he continued.
The BEAT works as a sort of alternative minimum tax on multinational companies with foreign subsidiaries, aimed at stopping earnings stripping that would reduce a company’s tax liability to less than a specified percentage of taxable income: 5 percent in 2018, 10 percent through 2025, and 12.5 percent in 2026 and thereafter. If a company’s tax liability is reduced below the applicable percentage after calculating applicable tax credits except for the research credit, then the gap between those amounts is collected as tax under the BEAT.
In a December 16 analysis posted shortly after the conference committee made the final version of the tax legislation public, Keith Martin of Norton Rose Fulbright wrote that tax equity investors are faced with the problem of triggering the BEAT after they enter into deals.
Martin explained that this issue is somewhat mitigated by limiting the clawback potential for the investment tax credit and the production tax credit — though that limitation only lasts through 2025, after which, absent additional legislation, the credits run the risk of being fully clawed back. Until that time, at least 80 percent of the credits would be usable.
Even so, the BEAT makes 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,” Martin wrote.
That difficulty is compounded by the time difference between when decisions about tax equity deals are made, and when they know if they’ll be subject to the BEAT, one renewable energy lobbyist told Tax Analysts. Banks and other financial institutions typically make those decisions at the beginning of the year, but won’t know until the end of the year if the BEAT will be triggered, and that uncertainty creates some additional risk and “leaves them a bit leery,” the lobbyist said.
Because some tax equity markets rely heavily on a small number of large, international investors, how the BEAT provision plays out for them will largely determine whether the TCJA’s impact is a ripple or a wave for the market.
“If we lose a couple multibillion-dollar investors like those big banks, then I think there will be a surplus in the market that will take potentially a year or two to absorb, and that will be a major effect,” said Jacobson.
The lobbyist, however, said 10 different developers — whether wind or solar developers or tax equity providers — will likely give 10 different answers on whether the base erosion tax would cause a big impact or little to no impact at all.
Cargas, speaking during the January 11 Norton Rose Fulbright webinar, said that he was aware of one or two tax equity investors that had exited the renewable energy tax equity market, at least temporarily, and presumably in response to the BEAT. Nevertheless, he sounded an optimistic note, saying that he expects a “steady state after the recalibration.”
Michael I. Sanders of Blank Rome LLP said that he thinks that investors “can live with the BEAT” despite the concerns, adding that because the tax only applies to large multinational corporations, its potential impact is less troubling for other tax credit industries with a more diverse pool of investors.
Investors in the historic rehabilitation tax credit community in particular dodged a potentially lethal bullet, but they still didn’t emerge unscathed from the tax law change, according to Rick L. Chukas, managing director of federal historic tax credits for Monarch Private Capital.
The House-passed version of the TCJA proposed to repeal the credit outright, but the final legislation incorporated the more modest Senate amendment, which repealed the 10 percent credit for buildings built in 1936 and earlier, and turned the one-year 20 percent credit into a 20 percent credit taken over five years.
Anticipation of changes or outright repeal of the historic tax credit had “brought the market to a halt,” Chukas said, adding that investors are now focused on several “technical uncertainties” in the TCJA transition rules that have come up post-enactment.
One uncertainty concerns whether the one-year historic credit can be claimed on projects in which the property was acquired before December 31, 2017, but rehabilitation work did not begin for the next 24 to 30 months, Chukas said. Investors are “still trying to figure out what their ultimate tax liability might be, what their appetite for tax credits might be, and how they want to attempt to seek them,” he said.
Jacobson also predicted woes for smaller historic rehabilitation credit deals. He said changes to the credit create a present value payment instead of an upfront payment — meaning that in year 1, a $1 million credit has essentially become a $200,000 credit. For smaller projects, some investors will say that’s too small to be worth the trouble, he explained.
Jacobson said that while it’s been suggested that investors would pay the same price for historic credits, just now over a five-year period, deals could be further complicated when developers who need the investors’ funds upfront will have to get a bridge loan by borrowing against those payments to cover the time gap.
If lawmakers are looking for ways to address the concerns in the tax credit financing industry, those in the community have plenty of recommendations and are eyeing the prospect of a technical corrections bill for the TCJA.
Sanders, however, was doubtful that Congress would come up with a technical corrections bill this year, which he worried would extend the uncertainty among investors. He also wondered how long it would take for Treasury to provide guidance and issue regulations. “The IRS has a tremendous burden — I mean this could go on for years,” he said.
In the meantime, Sanders said that targeted legislation could help address concerns with specific credits on the market, like what was offered in the Affordable Housing Credit Improvement Act (S. 548). Likewise, he predicted that there would be a strong push to extend the new markets tax credit scheduled to expire by 2020.
To help keep small investors involved in the markets, Jacobson suggested federal credits should follow the model of many state tax credits, which are often transferable by means of a certificate. That would significantly reduce the cost and complexity of entering into a deal, which typically requires investors to invest in a partnership before receiving credits from developers, and thus make small deals more viable to a wider pool of investors, he argued.
Jacobson also said that the statutory expiration dates of some credits, like the new markets tax credit or the renewable energy investment and production credits, are less attractive to new investors who are reluctant to try something that may soon disappear. Certainty, whether through permanence or expiration, would address that, he said.
Further guidance on the base erosion tax will also help, according to the renewable energy lobbyist. Tax equity investors “want to know they’re gonna put their money in, and they’re gonna get their money out,” he said.
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