2018 and Onward: The Impact of the House-Senate Compromise Tax Plan on the Renewable Energy Market

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1 Legal Update December 19, and Onward: The Impact of the House-Senate Compromise Tax Plan on the Renewable Ten days before Christmas 2017, the conference committee released the final text of the US tax reform bill along with an explanatory statement of the committee. After months of debate between the House and the Senate, the final bill would reduce the corporate tax rate to 21 percent beginning in The conference committee bill reflects a compromise between the House bill and Senate amendment. To the benefit of renewable energy sponsors and certain tax equity investors, the final bill partially mitigated the negative impact of the Senate s base erosion anti-abuse tax ( BEAT ) by allowing affected multinational corporations to generally benefit from 80 percent of their renewable energy tax credits for purposes of calculating BEAT through the end of 2025 (as explained below). However, that benefit would end under the final bill starting in 2026, when affected taxpayers would no longer be able to benefit from any tax credits for purposes of calculating the BEAT, if any. The benefit is also muted by the expanded reach of the final bill to corporations that make three percent of their deductible payments to foreign affiliates, which is an increase from the four percent threshold under the Senate bill. For banks, the BEAT provisions would apply if payments to foreign affiliates are two percent of deductible payments. Further, the final bill would repeal the corporate alternative minimum tax ( AMT ), which is necessary to avoid the loss of certain production tax credits ( PTCs ), which are an AMT preference when generated by projects after their fourth year of operation. In addition, the final bill would allow immediate expensing for newly acquired property under a provision that combines parts of each of the House and Senate bills, notably following the House bill in permitting 100 percent expensing of newly acquired used property. Further, the wind industry and its tax equity investors avoided a significant economic loss by the exclusion of the House provision that would have eliminated the inflation adjustment that increases the value of PTC from 1.5 cents to 2.4 cents per kilowatt hour. Industry participants who were sweating over the implications of the codified start of construction on the current phase-out and phase-down rules for the PTC and the investment tax credit ( ITC ) can breathe a sigh of relief, as none of those provisions survived conference committee. The renewable energy industry avoided the most onerous aspects of the House bill but did not fully escape the impact of the Senate s BEAT provision. Corporate Tax Rate and AMT The final bill would reduce the corporate tax rate to a flat 21 percent (subject to a few exceptions), replacing the current graduated rate structure capped at 35 percent for income that exceeds $10 million. This 21 percent rate would be incrementally beneficial for operating projects

2 that are beyond their depreciation period. For new projects, the lower rate would reduce the amount of tax equity a project can raise; however, the uncertainty of tax reform was hampering the market more than the reduced tax rate is expected to. The final bill, like the House bill, provides that the reduced tax rate would take effect for tax years beginning in 2018 rather than those beginning in 2019 as provided in the Senate version. This means tax equity investors would value depreciation deductions at the 21 percent tax rate and therefore would begin calculating their tax appetite using a 21 percent tax rate, rather than a 35 percent tax rate, beginning in In addition, following the House bill, the final bill would repeal the corporate AMT. In contrast, under the Senate bill, corporations would be required to pay higher tax when any of their income qualifies as AMT preferences. PTCs from projects more than four years old are an AMT preference. Therefore, when the income tax rate and the AMT rate are only one percent apart, taxpayers would not have been able to use the bulk of their AMT preference PTCs. As the final bill would eliminate the corporate AMT, taxpayers would not have that concern. Expensing The final bill, like the House and Senate versions, sets forth an additional first-year expensing of qualified property at 100 percent. But unlike the House bill, which provided more permanent deductions, the final bill followed the Senate bill in requiring that property must be acquired and placed in service after September 27, Notably, the final bill also effectively eliminated the original use requirement. It follows the House version by permitting used property to be fully expensed in the first year if the taxpayer has not used the property before. This would provide opportunities for acquiring operating projects, including repowered projects. To prevent abuses, used property acquired from certain related parties would be ineligible for expensing. The anti-abuse rule could be a challenge for wind tax equity transactions in which the parties desire to benefit from expensing, if the investor has not made its investment in the partnership on or prior to when the project is placed in service (i.e., when the project has essentially become operational), which would require the investor to take construction risk. The transition rules and effective dates under the final bill would create the opportunity for the owners of certain projects to expense them and benefit the deduction at the 35 percent corporate tax rate that applies in This opportunity would generally apply to investors that either acquire the project in a sale-leaseback or are using an investment vehicle that is not a partnership. The expensing provision would not treat partnerships differently than other taxpayers; however, the ability of partners in a partnership to claim deductions is limited by factors such as the partner s outside basis and the capital account rules. Those factors may make it difficult for partners to use the expensing deduction without causing other issues. A partnership that is in its first year of doing business can elect out of expensing and claim 50 percent bonus depreciation (40 percent for most property placed in service in 2018). Further, all taxpayers can opt for MACRS depreciation (e.g., five-year double declining balance for wind and solar property) or the alternative depreciation system (e.g., 12-year straight-line for wind and solar property). 2 Mayer Brown 2018 and Onward: The Impact of the House-Senate Compromise Tax Plan on the Renewable

3 Amounts of Eligibility for the PTC and ITC Like the Senate bill, the final bill retained the benefit of the inflation adjustment for the amount of the PTC. Under the House bill, the amount of the PTC would not have been increased for inflation; for instance, a wind farm that generated a 2.4 cent per kilowatt hour PTC in 2017 would have generated only a 1.5 cent per kilowatt hour PTC in Fortunately, the final bill follows the Senate approach of preserving the inflation adjustment. In addition, to be entitled to a PTC or ITC at a specific level, the wording of the House bill s continuity of construction rules to establish start of construction would appear to have required a project to be constructed on a continuous basis from the deadline for the specific PTC or ITC level through the date the project is placed in service. This would have been be a change from the standard set forth in IRS guidance, including by eliminating a safe harbor on which many projects currently under construction had relied. As a result, under the House bill s statutory language, projects may have only qualified for lower levels of PTC and ITC. Fortunately, the final bill excludes these provisions. BEAT Provisions The BEAT provisions were first introduced in the Senate bill and aroused wide concern in the renewable energy sector. The BEAT provisions target earning stripping transactions between domestic corporations and related parties in foreign jurisdictions. The BEAT would be a tax (at a phased in rate discussed below) on the excess of an applicable corporation s (I) taxable income determined after making certain BEATrequired adjustments, over (II) its adjusted regular tax liability ( ARTL ), which is its regular tax liability reduced by all tax credits other than, through the end of 2025, certain favored tax credits. The favored credits are (A) research and development tax credits and (B) up to a maximum of 80 percent of the sum of the low-income housing tax credits and the renewable energy tax credits. This favored treatment of the low-income housing and renewable energy tax credits was in response to concerns raised by those industries. However, the favored treatment is at best a partial mitigant to the impact of the BEAT on the value of those tax credits and the associated investments. The ability to exclude the renewable energy credits from the ARTL calculation ends beginning in In particular for PTCs, this could be a deterrent given the 10-year stream of those credits. Further, the final bill did not change the BEAT provisions in the Senate bill to distinguish between PTCs and ITCs earned with respect to projects that have already been placed in service or for which construction has begun. Thus, BEAT could affect monetization of tax credits mid-stream. It could also affect renewable energy credits earned with respect to projects in which tax equity is currently invested. Another issue is that the final bill would expand the reach of the BEAT because the threshold for being subject to the tax is lower than under the Senate version. Under the Senate version, corporations that make payments to their foreign affiliates equal to four percent of their deductible payments are subject to the BEAT regime. Under the final bill, the threshold would be reduced to three percent; and two percent for banks. Confounding the problem is that these companies will not know in advance whether the BEAT will apply and this uncertainty could cause susceptible tax equity to leave the market. The final bill provides a phase-in for the final BEAT rate. Under the phase-in, the BEAT would 3 Mayer Brown 2018 and Onward: The Impact of the House-Senate Compromise Tax Plan on the Renewable

4 be five percent for tax years beginning in 2018, 10 percent for tax years beginning between 2019 and 2025 and 12.5 percent thereafter. In the case of banks and securities dealers, the general BEAT rate would be increased by one percentage point, such that their BEAT rate would be six percent for taxable year 2018, 11 percent for taxable years 2019 through 2025 and 13.5 percent thereafter. The higher BEAT rate would also apply to corporations and other entities that are members of the same affiliated group of a bank or securities dealer. The higher rate for the specified financial institutions was the pay for for allowing the specified financial institutions to exclude payments with respect to derivatives to their foreign affiliates from BEAT. Orphaned Tax Credits Under current law, the tax credits for projects that use fuel cells, geothermal, biomass, combined heat and power, landfill gas, small wind, solar illumination, incremental hydro and ocean energy resources have lapsed. The tax credits for the orphaned resources were inadvertently excluded from the 2015 tax credit extension for wind and solar. The House bill would have reinstated the tax credits for these orphaned resources, such that qualified projects using these technologies would be subject to the same requirements and phase-out percentages as qualified solar facilities. Unlike the House bill, neither the final bill nor the Senate amendment would reinstate the tax credits for those resources. Senator Lisa Murkowski (R-AK) observed this week that the Congress would address the issue of currently lapsed energy tax credits in an extenders bill early next year. Technical Termination of Partnerships The final bill, like the House bill, would repeal section 708(b)(1)(B) of the tax code, which causes a partnership to be deemed to terminate (a so-called technical termination ) when there is a sale or exchange of 50 percent or more of the total interest in the partnership s capital and profits during a 12-month period. In the case of such a deemed termination, the terminating partnership is deemed to transfers its assets and liabilities to a new partnership and the terminating partnership is deemed to distribute interests in the new partnership to the purchasing partner and other partners of the terminating partnership. One result of the termination is that the recovery period for depreciating the partnership s assets is restarted. There is a special bonus depreciation rule that provides that the new partnership is the entity entitled to claim the deduction for bonus depreciation for property placed in service during the year of the technical termination. The technical termination rule combined with this bonus depreciation rule enabled tax equity investors in wind projects to avoid construction risk and still receive bonus depreciation by waiting until after a project was up and running smoothly to acquire an interest in the terminating partnership. The resulting new partnership could claim bonus depreciation even though the old partnership had placed the project in service. Thus, tax equity investors were able to invest in operating wind projects, qualify for bonus depreciation and only lose a few weeks of the 10-year PTC stream. With the 100 percent expensing provisions in the final bill, such structuring would not be necessary, as used property qualifies for expensing so long as the wind project is newly acquired by the taxpayer and the acquisition is not subject to the anti-abuse rules regarding related-party acquisitions (which may still present issues in the case of tax equity partnerships). Note that the final bill does not alter the ITC prohibition with respect to used equipment, so ITC investors will still need to invest at or before the placed-in-service date or 4 Mayer Brown 2018 and Onward: The Impact of the House-Senate Compromise Tax Plan on the Renewable

5 execute a sale-leaseback within three months thereof. The repeal also would simplify transfers of interests in tax equity partnerships, which were often restricted by provisions in the partnership operating agreement prohibiting transfers that would result in a technical termination of the partnership. Without the need for this constraint, it will be possible to remove one of the most complex aspects of partnership transfers. Prepaid Power Purchase Agreements The final bill has a provision that could eliminate the tax deferral benefit of a prepaid power purchase agreement ( PPA ). Under a prepaid PPA, the offtaker (or residential customer) prepays some or all of the projected cost of the power to be delivered during the term of PPA. Current market practice is that the seller of the power (in many transactions, the tax equity partnership) defers the income recognition until the power is actually delivered. The final bill would require sellers to report prepayments for certain goods and services identified by Treasury in the year received or the year following receipt. Until Treasury actually identifies the affected goods and services, it cannot be known whether this provision in the final bill would apply to prepayments for power under PPAs and, thus, eliminate the ability to defer income recognition under prepaid PPAs for tax purposes. It would mean the loss of a significant tax benefit to the energy industry if Treasury were to identify power among the goods and services for which prepayments must be recognized as income in the year of receipt. Treasury s typical practice would be to have such identification only apply to contracts entered into after the list of identified goods and services is published. Therefore, the power industry has the opportunity to make its case to Treasury that PPAs should not be included on Treasury s list. Nonetheless, the ad terrorem effect of the possibility of the list including PPAs and an uncertain effective date of the list is likely to discourage parties from including the tax deferral benefit of prepaid PPAs when bidding on or structuring transactions. It should be noted that the final bill would not make prepaid PPAs impermissible even if Treasury includes power on the list; such inclusion would merely deny power sellers the timing benefits of income deferal for tax purposes. If the transaction economics are acceptable to the power seller without deferral, parties may opt to continue to include the prepayment feature, as some offtakers find it to be an economically attractive means to deploy their available cash. Final Bill Likely to Pass Passing the bill in short order appears likely as the Republican senators who previously objected to the bill have now voiced their support. Senator Bob Corker (R-TN) said to the press that he would vote for the tax bill. Senator Corker voted against the Senate bill out of a concern that the tax cuts would expand the budget deficit. He was the only Republican who voted no on the Senate bill. Senator Marco Rubio (R-FL) also agreed to support the final bill. He and Senator Mike Lee (R-UT) actively proposed increasing the refundable child tax credit. Senator Rubio communicated his support for the final bill upon the inclusion of an increase in the child tax credit. 5 Mayer Brown 2018 and Onward: The Impact of the House-Senate Compromise Tax Plan on the Renewable

6 For a brief summary of changes in the House-Senate bill with respect to the renewable energy sector, please refer to the chart below. HOUSE BILL SENATE BILL FINAL BILL INFLATION ADJUSTMENT TO PTC Repealed inflation adjustment to PTC calculations for projects that start construction after the enactment of the proposed legislation, reducing the PTC from 2.4 cents per kwh to the base rate of 1.5 cents per kwh. START OF CONSTRUCTION RULES Required continuous construction on a project from the deadline for the specific PTC or ITC level through the date the project is placed in service. ORPHANED RENEWABLE ENERGY TECHNOLOGIES Reinstated the renewable energy tax credit for qualified projects. Qualified projects would be subject to the same requirements and phase-out percentages as qualified solar facilities. No extension. No extension. CORPORATE TAX RATE Replaced the graduated corporate tax rate structure currently in effect with a 20 percent rate on the taxable income of corporations beginning in Replaced the current corporate tax rate structure with a 20 percent rate on the taxable income of corporations beginning in Replaced the current corporate rate structure with a 21 percent tax rate on the taxable income of corporations beginning in EXPENSING Provided 100 percent immediate expensing for personal property acquired and placed in service after September 27, 2017 through the end of This additional first-year depreciation deduction would supersede the current 50 percent bonus depreciation rules except for new taxpayers filing their first tax returns. Provided 100 percent immediate expensing for property acquired starting on September 27, The expensing would phase down by 20 percent annually for property placed in service after December 31, 2022 and before January 1, This additional first-year depreciation deduction would supersede the current 50 percent bonus depreciation rules except for new taxpayers filing their first tax returns. Immediate expensing for property acquired after September 27, This additional first-year depreciation deduction would supersede the current 50 percent bonus depreciation rules except for new taxpayers filing their first tax returns. 6 Mayer Brown 2018 and Onward: The Impact of the House-Senate Compromise Tax Plan on the Renewable

7 HOUSE BILL SENATE BILL FINAL BILL ALTERNATIVE MINIMUM TAX Repealed the individual and corporate AMT. Retained AMT for corporations and individuals. Only PTCs generated in the first four years of a project s operation are not AMT preferences. Retained individual AMT while repealing the corporate AMT. BEAT No change to current law, which does not contain BEAT. Imposed tax on the amount of taxpayer s BEAT liability in excess of their regular tax liability. Imposed tax on the amount of taxpayer s BEAT liability in excess of their regular tax liability. The bill would allow 80 percent of the PTC and ITC to offset 80 percent of BEAT only until PREPAID PPAS Deferral limited to the year after receipt with respect to prepayments for goods and services identified by Treasury. Follows the Senate bill. For more information about this topic, please contact any of the following lawyers. David K. Burton dburton@mayerbrown.com Jeffrey G. Davis jeffrey.davis@mayerbrown.com Anne S. Levin-Nussbaum alevin-nussbaum@mayerbrown.com Mayer Brown is a global legal services organization advising clients across the Americas, Asia, Europe and the Middle East. Our presence in the world s leading markets enables us to offer clients access to local market knowledge combined with global reach. We are noted for our commitment to client service and our ability to assist clients with their most complex and demanding legal and business challenges worldwide. We serve many of the world s largest companies, including a significant proportion of the Fortune 100, FTSE 100, CAC 40, DAX, Hang Seng and Nikkei index companies and more than half of the world s largest banks. We provide legal services in areas such as banking and finance; corporate and securities; litigation and dispute resolution; antitrust and competition; US Supreme Court and appellate matters; employment and benefits; environmental; financial services regulatory and enforcement; government and global trade; intellectual property; real estate; tax; restructuring, bankruptcy and insolvency; and wealth management. Please visit for comprehensive contact information for all Mayer Brown offices. Any tax advice expressed above by Mayer Brown LLP was not intended or written to be used, and cannot be used, by any taxpayer to avoid U.S. federal tax penalties. If such advice was written or used to support the promotion or marketing of the matter addressed above, then each offeree should seek advice from an independent tax advisor. Mayer Brown comprises legal practices that are separate entities (the Mayer Brown Practices ). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe-Brussels LLP, both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorized and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC ); Mayer Brown, a SELAS established in France; Mayer Brown Mexico, S.C., a sociedad civil formed under the laws of the State of Durango, Mexico; Mayer Brown JSM, a Hong Kong partnership and its associated legal practices in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. Mayer Brown Consulting (Singapore) Pte. Ltd and its subsidiary, which are affiliated with Mayer Brown, provide customs and trade advisory and consultancy services, not legal services. Mayer Brown and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions. This publication provides information and comments on legal issues and developments of interest to our clients and friends. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek legal advice before taking any action with respect to the matters discussed herein The Mayer Brown Practices. All rights reserved. 7 Mayer Brown 2018 and Onward: The Impact of the House-Senate Compromise Tax Plan on the Renewable