The already buzzing clean energy tax credit market got the final word from the Treasury Department on the rules that will govern the fast-growing space earlier this week.
- The top line: The Internal Revenue Service said it received about 80 comment letters on the draft guidance published in June 2023, but the final rules largely declined to implement requested changes. The most notable proposed changes that didn’t make the final cut impact who can buy credits, how credits can be sliced and sold, and how credit marketplaces must operate.
- The market grounding: Born from the Inflation Reduction Act’s transferability clause, the tax credit transfer market has already been growing more quickly than expected, reaching up to$9 billion in the second half of 2023. Treasury guidance went into effect in June, and in the first six months of trading, the total value of tax credit transfer deals climbed to roughly one-third the value of traditional tax equity.
- The current take: Alfred Johnson, CEO of the startup and tax credit marketplace Crux, told Latitude Media that though the transferable tax credit market was already up and running, the additional guidance gives “further clarity” on the pathway for financing clean energy and manufacturing projects. “With these final rules set, we expect to see the market continue to accelerate rapidly,” Johnson said.
The finalized guidelines largely stick to draft guidance released last summer, explained Keith Martin, co-head of projects at Norton Rose Fulbright. Those guidelines allow for 11 types of credits to be sold, including credits for capturing carbon, manufacturing solar components, and building new factories.
In the final rules, Martin said, the IRS “mostly rebuffed” suggestions to make it simpler for individuals to buy credits; it also declined to allow tax credit buyers to pay in advance for production tax credits claimed over 10 or 12 years for captured carbon or electricity output.
A handful of additional changes sought by market participants but rejected by the IRS would have impacted the operation of tax credit marketplaces, which have been springing up over the course of the last year.
Many who submitted comment letters on the draft guidelines wanted the IRS to allow project owners to sell bonus tax credits separately from the base credits. (Bonus tax credits can be claimed for projects in energy communities — including areas with brownfields or closed coal mines — or low-income areas.)
“The IRS stuck to its position that a project owner can sell a percentage of the total tax credit for which the project qualifies, but not strip out a bonus tax credit and sell just that,” Martin said in a Thursday memo. “This has been an issue in tax equity financings where the tax equity investor is not willing to take a bonus credit into account in pricing. The developer would prefer to keep the bonus credit and sell it separately.”
Johnson said the decision not to allow for “horizontal slicing” of tax credits — which proponents argued would have provided more flexibility to distribute risk — didn’t come as a surprise to the market at large, which has been “functioning well without this capacity.”
“Most commonly, we are finding that tax equity or tax credit deals can be sized without taking account of bonus credits, with the ability to increase the deal if adders are obtained by the seller and can be substantiated,” Johnson said. “In practice it might have been more challenging for developers to monetize bonus adders if they were required to be sold separately from the base tax credit purchase.”
Marketplace guardrails
The IRS also rejected requests from brokers and intermediaries to create a more liquid trading market, by allowing credits to be sold more than once. Instead, the agency warned such middlemen to be careful; as Martin pointed out, if tax credits have already been transferred to intermediaries, a retransfer to a client “will run afoul of a rule that tax credits cannot be sold twice.”
That means that trading platforms popping up “cannot make a market in tax credits by buying and reselling,” Martin continued. “They will still try to act as a meeting place for people who want to sell or buy tax credits.”
Johnson said that decision, like the decision on bonus credits, was largely to be expected.
He added that Crux is “aware of some service providers who position themselves as tax credit offtakers [or] intermediaries, who provide financing in addition to some tax credit placement services.” In general, however, he sees the role of most brokers in these new marketplaces as more akin to a “best efforts” role in investment banking, in which the underwriter isn’t obligated to purchase the securities if they can’t find buyers, rather than a firm underwriting commitment, in which the seller is essentially guaranteed that all of their shares will be sold, because the underwriter has bought them first.
“The strategy Crux and others would employ is to endeavor to facilitate the one-time sale between the taxpayer and the credit buyer,” he said.
That said, Crux itself occasionally acts as an intermediary, facilitating connections between buyers and sellers on the platform. That’s part of the company’s strategy to build “a large, liquid and transactable market for tax credits,” Johnson said.
“But in the majority of cases an intermediary partner is using our software and platform to source and manage transactions.”
