New guidance from the US Internal Revenue Service explaining how tax credits for clean energy projects can be transferred under the Inflation Reduction Act is not likely to establish a simpler alternative to the existing, tax equity-based framework, according to several project finance attorneys.

Until recently, developers of large-scale wind and solar installations could often only monetize federal tax credits by selling them to large financial firms and other companies with significant tax liabilities by creating partnerships that owned projects.

The Inflation Reduction Act allows developers to convert tax credits into cash payments themselves by selling the credits to unaffiliated corporate entities, opening the door for direct project ownership and potentially creating extra income from unused credits as transfer markets materialize. Industry players from investor-owned utilities to private project developers have been awaiting clarity from the Biden administration on the specifics of how this new system could work.

Tax credit complications

But instead of eliminating the burdensome due diligence required for tax equity financing, transferability is "looking to be just as thorough and complicated" based on the proposed clarifications, which still need to be finalized, Anne Loomis, an energy tax attorney for Troutman Pepper Hamilton Sanders, said in an interview.

Keith Martin, Norton Rose Fulbright renewable energy tax expert and co-head of projects, agreed in an interview that "the bottom line from this guidance is tax credit sales will be 'tax equity light.'"

"They're not the simple transaction I think some digital platforms hoped for," Martin said in an interview, adding that any deals already signed will have to be amended to account for a preregistration process mandated by the IRS and the minimum documentation proving that the project and the credits exist.

The guidelines also allocate to tax credit buyers the risk that investment tax credits will have to be taken back, or recaptured, if there are any ownership changes within a project's first five operating years. Project finance attorneys interviewed for this story said they had anticipated that sellers would be responsible.

That risk will be "pretty onerous" for buyers, and any "credit support backstopping the transferors' representations are going to impact pricing," Mona Dajani, a project development and finance attorney at Shearman & Sterling, said in an interview. In addition, the guidelines impose a 20% penalty for excessive transfers that can only be avoided by significant due diligence involving third parties to confirm the availability and amount of credits in a transaction, Dajani added.

Those backstops will likely "create more opportunities for insurers in the space, especially for less creditworthy transferors and definitely benefit transferors who can provide the indemnities that are required to support the exposure the transferees will have to assume," Baker Botts LLP's project finance attorney, Ellen Friedman, said.

Partnership 'wrinkles'

Questions also persist regarding how the recapture of tax credits applies to changes in partnership and pass-through entity interests, according to Troutman Pepper's Loomis.

"We were hoping the regulations would say that, that sort of indirect disposition by a seller wouldn't constitute recapture of a transferred credit but that wasn't the answer," meaning that recapture risk is shared by buyers and sellers, Loomis said. "That just creates some wrinkles in the structuring and thinking about what the indemnifications need to look like."

The Inflation Reduction Act, for the first time, also allows tax-exempt organizations such as electric cooperatives and businesses with limited tax liabilities to claim the equivalent of a tax credit as a cash payment from the IRS, known as direct pay.

But the guidance stipulates that partnerships that include both tax-exempt and taxpaying entities do not qualify for direct pay, while making it harder for such partnerships to economically transfer credits, according to Loomis.

"The transfer regulations say that the tax-exempt use property rules apply, which means you would end up with a haircut of credit based on the tax-exempt partner," Loomis said, leaving those partnerships "in an impossible position, and so that form of doing business doesn't appear to be an option for how tax-exempts can participate in the market."

Greater clarity on the tax credits is also likely to shape utility investment plans. Xcel Energy Inc., for example, said it has had hydrogen developers and other companies lining up to purchase $200 million in renewable energy tax credits from the utility in anticipation of the new transferability provision.

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