27 February 2014
On February 26, 2014, US House Committee on Ways and Means Chairman Dave Camp released draft tax reform legislation entitled the Tax Reform Act of 2014 (the “Draft”). According to Chairman Camp, the overarching goal of the Draft is to “fix America’s broken tax code by lowering tax rates while making the code simpler and fairer for families and job creators.” One method proposed by the Draft is to eliminate dozens of credits, deductions and other incentives. Although it is highly unlikely that the Draft will be enacted into law in its current form, it represents a significant first step on the long road to fundamental tax reform.
There are a number of proposals in the Draft that could adversely impact the renewable energy industry. Two of them are particularly noteworthy because of the potentially retroactive effect: the elimination of the inflation adjustment factor for the Section 45 production tax credit (“PTC”) for wind projects, and the addition of a continuous construction requirement for wind projects that are placed in service after 2013 to qualify for the PTC.
Elimination of Inflation Adjustment for the PTC; Phase Out of the PTC
Under current law, the PTC is 1.5 cents per kWh adjusted for inflation, which made it worth 2.3 cents per kWh for 2013. The Draft would eliminate the inflation adjustment after 2014, thereby reducing the value of the PTC by over one-third, to 1.5 cents per kWh for electricity produced and sold after 2014. This reduction would apply not only to projects placed in service after 2014, but to projects that were placed in service in 2014 or earlier, notwithstanding that those projects were constructed and financed in reliance on the inflation adjustment. That would be a detrimental blow to existing projects, and it highlights the need to give further consideration to who, as between developers and tax equity investors, should bear the risk that the PTC rate is reduced.
In addition, the Draft would eliminate the PTC entirely for electricity produced and sold after 2024. That would reduce the 10-year period during which PTCs otherwise would be available for projects where construction began in 2013 but which are not placed in service until after the beginning of 2015.
The summary of the Draft states that businesses in the wind industry indicated that “the industry could survive with a credit worth 60 percent of the current credit, implying that the credit provides a windfall that does not serve the intended policy.” It is not likely that those businesses contemplated that Congress would use such a concession to retroactively reduce the PTC for projects that had been developed or financed in reliance on an inflation adjusted PTC. Moreover, there is a big difference between “survive” and “thrive” – which sets the stage for the debate on how far the tax code should go toward promoting renewable energy.
Change in Determining Beginning of Construction for the PTC
The Draft would require that construction of a wind project be continuous. That would override the safe harbor provided by the IRS, which deems construction to have been continuous for a project that is placed in service by the end of 2015. This proposal could be a real game changer; the mere suggestion that the IRS guidance is more liberal than Congress intended could have a chilling effect on projects that are relying on the IRS safe harbor. It also raises the question of whether the Draft may constitute a "proposed change in tax law" under debt or tax equity financing agreements.
Elimination of the ITC
The Draft would eliminate the Section 48 investment tax credit (“ITC”) for property placed in service after 2016, which effectively repeals the 10 percent ITC for solar projects placed in service after 2016. The summary of the Draft indicates that the elimination of the ITC would have no revenue effect over 2014-2023, although that seems to ignore the post-2016 repeal.
Elimination of MACRS Depreciation
The Draft would eliminate the depreciation rules under the Modified Accelerated Cost Recovery System (“MACRS”) and replace them with rules similar to those under the Alternative Depreciation System (“ADS”). This means that cost recovery would be made using the straight-line method over a newly assigned class life that would be intended to more closely match the true economic useful life of assets. The change would be effective for property placed in service after 2016. Under current law, the cost of wind and solar property is recovered using a five-year class life. Under the Draft, the class life would be stretched out to a minimum of 12 years and perhaps 20 to 25 years or longer.
Links to the draft Tax Reform Act of 2014 and related materials are provided below.
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