Background
The Inflation Reduction Act (IRA), the largest climate investment in U.S. history, has provided various incentives to assist in developing and deploying clean energy technologies. One of these incentives is the ability for a solar photovoltaic renewable energy project to elect a production tax credit (PTC) instead of an investment tax credit (ITC). The PTC, typically reserved for wind turbine projects, is a production-based credit calculated annually based on the amount of kilowatt-hours (kWh) generated by the renewable energy project. The typical eligibility period for PTC credits is 10 years. The ITC, the only available credit for solar photovoltaic renewable energy projects pre-IRA, is a one-time credit based on a percentage of eligible costs for the respective project. The renewable energy project is typically eligible for the ITC in the year that the project is placed into service.
Qualitative Factors
While industry experts have focused on the quantitative factors and modeled scenarios as to which credit is more beneficial, developers also should be aware of the qualitative differences between a renewable energy project that has elected an ITC or PTC. The ability to monetize either tax credit through traditional tax equity is relatively consistent. In both instances, the most common approach is to sell the renewable energy project from an affiliated entity into a tax equity partnership. The developer retains the sponsor interest in the tax equity partnership while a third-party tax equity investor participates by acquiring the investor member interest in the tax equity partnership. Taxable loss allocations/benefits vary throughout the tax equity partnership’s life as governed by the respective operating agreement. In the early years of the arrangement, the tax equity partner will be allocated most of the income/loss until a targeted return amount or date is reached. At that time, the ownership allocations will flip with the sponsor then being allocated most of the income/loss going forward. This structure is referred to as a partnership flip. After a flip in ownership allocations, most partnership agreements allow for the sponsor interest to call the remaining tax equity investor’s interest and/or the tax equity investor to put its remaining interest to the sponsor.
In historical ITC tax equity partnerships, the flip date (or flip point) is typically based on a future date. After that date, typically right after the five-year recapture period, ownership allocations flip and the developer—through its ownership of the sponsor interest—can wholly own tax equity partnership via execution of the call option. A tax equity partnership with a fixed flip date is typically less complex than other structures used in practice. Renewable energy developers who have focused on ITC solar photovoltaic renewable energy projects may have only experienced tax equity partnerships with a fixed flip date.
The flip date of a PTC tax equity partnership is almost exclusively based on an internal rate of return (IRR) that the tax equity investor needs to achieve for the owner allocations to flip. The tax equity investor achieves their IRR through a combination of taxable loss benefits, PTCs allocated, and priority return distributions throughout the partnership’s life. At project inception, the project model typically estimates that the tax equity investor will achieve their IRR shortly after the 10-year PTC period. At minimum, developers should plan on the PTC tax equity partnership being in place for 10 years through the PTC eligibility period. In practice, the length of the partnership may be exponentially extended if the tax equity investor’s IRR per the original model is less than actual results. Because the PTC is directly tied to production, future events such as weather, e.g., Winter Storm Uri; curtailment; equipment issues; and inaccurate financial models can lead to the tax equity partnership surviving much longer than anticipated.
What to Consider
While quantitative factors of the analysis such as bonus credit scenarios, project capital expenditures costs, financing costs, and capacity factors are extremely important, developers also should consider the inherent complexities of a PTC tax equity structure as compared to a typical ITC structure. Developers have an obligation to understand the various options at their disposal to increase their investment, and this piece of the IRA continues to be uncharted territory for many organizations.
If you or your organization need help analyzing the ITC or PTC decision, please reach out to a renewable energy professional at FORVIS.