The Inflation Reduction Act of 2022 (IRA), which was signed into law on August 16, 2022, enacted a wide range of legislation addressing climate change, healthcare, prescription drug pricing, and tax matters. Specific to energy storage, the act’s changes to the Internal Revenue Code of 1986, as amended (Code), have the potential to be a game-changer for the energy storage industry in the United States, in terms of both deployment and equipment manufacture. This is due to the act’s expansion of federal income tax credits for standalone energy storage facilities and for the manufacture of energy storage equipment, as well as its expansion of opportunities for monetizing these tax credits.
New Tax Credits for Energy Storage Industry
Critically, the act provides a federal investment tax credit (ITC) for a broad set of standalone energy storage facilities, including those employing battery, hydrogen, and thermal energy technologies. A separate ITC for energy storage had long been sought by the green technology industry, as the preexisting tax rules had been very cumbersome and were a roadblock to incentivizing grid stabilization through storage build-out. This was due to the operation of the preexisting ITC rules, which required storage to augment solar or wind ITC generation property and allowed for only limited grid charging.
Public Utility Property Designations
The act also provides an election out of the Code Section 50(d)(2) “public utility property” limitation for larger energy storage facilities (capacity in excess of 500 kilowatt hours (kWh)). This election, which the act only provides for energy storage facilities, accelerates the benefit of the ITC for regulated utilities into the year the facility begins operations, as compared to spreading the benefit over the projected useful life of the facility under the public utility property rules.
Therefore, the potential to elect out of public utility property status should further incentivize regulated utilities to spearhead storage expansion as part of their infrastructure spending. Moreover, given the ability of energy storage to act as a non-wires alternative (NWA), this election will facilitate utility ownership and rate basing of energy storage projects. Utilities that intend to take advantage of the ITC through the acquisition of energy storage projects will need to carefully structure their procurement contracts to do so.
The act separately introduces certain standard-based incentives or “adders” and disincentives with respect to the act’s green technology industry tax credits, including the energy storage ITC, that could significantly impact the amount of the applicable tax credit. Critically, the tax credits for larger facilities are generally subject to an 80% haircut (although expressed in the Code as a 5-times multiplier) if a prevailing wage and apprenticeship standard is not satisfied (for example, a 30% ITC would become a 6% ITC).
At a high level, the applicable standard is that all laborers employed by the project owner, any contractor, or any subcontractor must be paid prevailing wages (based on the US Department of Labor’s published prevailing rates for such work in a particular locality) and a sufficient percentage of such laborers must be enrolled in a registered apprenticeship program under the National Apprenticeship Act, in each case with respect to the construction, alteration, and repair of the applicable facility.
The act includes potential adders that may apply with respect to renewable energy and energy storage tax credits. First, it provides a 10% increase in the credit for an applicable facility if it satisfies a “domestic content” standard based on any steel, iron, or manufactured product that is a component of the facility being produced in the United States under the federal Buy American Act standards.
The act provides a separate (potentially additional) 10% increase in the credit for an applicable facility located in an “energy community,” which includes a designated brownfield site, an area surrounding a coal mine closed after 1999 or coal-fired electric plant retired after 2009, or a designated tract with significant tax revenues or employment related to the extraction, processing, transport, or storage of coal, oil, or natural gas and with an unemployment rate at or exceeding the national average.
Finally, the act provides a separate (potentially additional) 10% and possible 20% credit increase for certain smaller renewable energy facilities, including those coupled with energy storage equipment, located in identified low-income communities or projects based on Treasury allocations of “environmental justice capacity limitation” with respect to the facility. Thus, there is (at least in theory) the possibility for a project that meets all of the adder criteria to receive ITCs in the amount of 70% of eligible project costs.
Production Tax Credit
Dovetailing with the onshoring and energy security policy objectives reflected in the “domestic content” adder described above, the act refreshes a preexisting ITC and enacts a new production tax credit (PTC) for manufacturing facilities located in the United States producing a wide array of green technology industry equipment, including energy storage equipment.
Moreover, the products produced by these manufacturing facilities may still be eligible for further tax credits on the deployment side as described above.
Monetization and Potential Impact and Opportunities
The act provides for refundable green technology industry tax credits, including for the energy storage facility ITC and the energy storage equipment manufacturing facility ITC and PTC. However, aside from limited exceptions, including for the green technology equipment (including energy storage) manufacturing facility PTC, only tax-exempt and US federal, state, local, or tribal governmental entities (including Alaska Native Corporations); the Tennessee Valley Authority; and corporations operating on a cooperative basis engaged in furnishing electricity to persons in rural areas are eligible for the refundable credit.
The act also allows for the novel ability of taxable entity project owners (generally, those not eligible to claim refundable credits) to sell all or a portion of their tax credits with respect to a particular year for cash. The initial buyer of a credit may not resell the credit.
These provisions have the potential to revolutionize the way green technology industry project financing is structured and expand the investor base for green technology industry facilities, including for energy storage.
Sale of Tax Credits
In particular, the ability to directly sell tax credits has the potential to fundamentally alter the market for green technology industry financing, which, with respect to renewable energy, has prior to the act consisted of tax-driven structures (partnership flips, sale-leasebacks, and inverted leases) to monetize tax credits given sponsors’ (i.e., developers’) frequent inability to effectively use the tax credits themselves.
As an example, under the common partnership flip structure, a “tax equity” investor must generally be a true project development joint venture “partner” (among other common law–based requirements) to effectively be compensated for capital investment with a disproportionate share of project tax credits (and depreciation). The tax credit sale provisions of the act allow investors to discard this paradigm and enjoy the type of no-risk, “pure play” tax credit purchase commercial arrangement they have long desired, although at the expense of not being able to receive the benefits of depreciation (which may not be sold along with the credits).
Although initial market indications are that there is still a desire for traditional tax equity financing transactions in which investors are beneficial equity owners of the underlying facility (and receive associated return from the operations of the facility and from disproportionate allocations of both tax credits and depreciation from the facility), the new ability to sell tax credits has the potential to expand the market of investors and for the monetization of the credits. For one, the ability to sell tax credits may have appeal, and expand financing opportunities, for smaller-scale developers and projects for which the significantly increased complexity and cost of implementing a traditional tax equity investment structure is less economically viable.
We also expect that the ability to sell tax credits will be critical for the development and financing of emerging and rapidly developing technologies, such as energy storage, and eligible manufacturing where tax equity investments have not to this point been deployed due to the perceived economic or legal risk associated with owning an equity ownership interest in the applicable facility (as compared to simply purchasing the tax credits).
Moreover, even if a partnership flip or other traditional tax-driven structure is employed to implement tax equity investor financing of a project, it may be possible (pending forthcoming IRS and Treasury guidance) to couple such an investment structure with a partial or complete sale of the underlying project’s tax credits. This could expand the pool of potential tax equity investors to include companies and other investors that may have a more limited tax capacity. It could also allow for the monetization of depreciation tax benefits, which may not be transferred. The monetization flexibility provided by the ability to sell credits may also expand the potential investor base for green technology infrastructure and technology projects, including for private investment funds with a broad climate strategy.
To-be-developed market pricing as among investors, lenders, and tax credit buyers will be critical in determining whether a net tax credit sale option results in a lower cost of capital for project sponsors versus conventional tax equity structures.
Market practice will no doubt take time to develop around the documentation and structures for these “pure play” tax credit purchases. Numerous technical questions will need to be addressed by Treasury and the IRS in implementing regulations and/or guidance on these transactions in order for a robust credit marketplace to develop.
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