Background
With the signing into law of the Inflation Reduction Act (IRA) in August 2022, many new clean energy tax credits and extensions/enhancements of existing tax credits are available to those in the renewable energy space. One of the most significant enhancements is the ability to transfer (sell) all or a portion of certain tax credits, such as an investment tax credit (ITC), to another taxpayer for tax years starting after December 31, 2022. For entities that cannot utilize the tax credit to reduce their own tax liability, selling the credit to another taxpayer provides an additional option to monetize the credit. The option to transfer these credits obviates an entity from incurring the time and resources needed to monetize the tax credits through traditional tax equity structures.
U.S. GAAP does not address how to account for ITCs that can be used by the entity or sold to another taxpayer. As a result, several acceptable models for the treatment of these credits are emerging in practice. One path is to account for the credits under the GAAP guidance ASC 740, Income Taxes. Another path is analogizing to International Accounting Standard (IAS) 20, Government Grants and Disclosure of Government Assistance. An entity selling a transferable tax credit will need to make an accounting policy election of which guidance to follow and consistently apply that methodology to all transferrable credits going forward.
Accounting Guidance Considerations – ASC 740 or IAS 20
For renewable energy projects owned by a partnership or similar pass-through entity, ASC 740 typically would not apply as the earnings and losses are passed directly to their owners for tax purposes. As a result, partnerships that own renewable energy projects that will receive ITCs that can be utilized by the entity or transferred to another taxpayer through a sell will likely need to look to IAS 20 for guidance.
Under IAS 20, a government grant is defined as government assistance in the form of transfers of resources for past or future compliance with certain conditions related to the entity’s operating activities. IAS 20 outlines two types of government grants: those related to assets and those related to income. Grants related to assets are those in which an entity constructs or otherwise acquires long-term assets to meet the compliance requirements of the grant. There can be additional conditions in asset-related grants that further restrict the type or location of the assets or periods during which the assets are acquired or held to qualify for the grant funds. Grants related to income are government grants other than those that are asset-related.
ITCs provide an entity a tax credit based on the eligible costs of the respective renewable energy project, generally solar. The amount of the credit can vary depending on the size of the project and certain other factors, such as prevailing wage and apprenticeship requirements. Since this credit is only received based on eligible capital spend, it would typically fall within the asset grant guidance versus the income grant guidance in IAS 20.
IAS 20 Explained
An asset grant can only be recognized when:
- There is reasonable assurance that the entity will comply with the conditions attached to the receiving grant and that the grant will be received.
- Receiving the grant itself does not provide conclusive evidence that the conditions attached to the grant have been or will be fulfilled.
IAS 20 does not outline what qualifies as “reasonable assurance.” However, when GAAP financial statement preparers analogize to IAS 20, they generally equate “reasonable assurance” to the GAAP term of “probable” outlined in ASC 450, Loss Contingencies. Probable is defined in ASC 450 as a future event that is likely to occur, which generally has been considered to be at least 75% complete. Once the ITC qualifies to be recognized under the grant guidance in IAS 20, typically, a reduction in the fixed asset will be recorded with an offset to a transferable tax credit asset for the fair value of the ITC. Due to the reduction in the fixed asset, depreciation expense will be reduced over the asset’s life, resulting in the credit being recognized in the income statement through the reduced depreciation expense. As the ITCs are sold, the transferable tax credit asset will be reduced, and any gain or loss will be recognized in continuing operations. An alternative approach to reducing the fixed asset typically acceptable under IAS 20 would be to record deferred income. Then other income would be recognized on a pro rata basis over the useful life of the related asset. This approach would result in the same balance sheet and income statement impacts as reducing the fixed asset and related depreciation expense. Still, it is a different presentation that some entities may prefer. The presentation methodology is an accounting policy election that will need to be made and then consistently followed going forward.
Example
Solar Partnership Co. builds a solar project with an eligible cost of $10 million. The project is placed in service on January 1, 2023 and has an estimated useful life of 25 years. The project qualifies for a 30% ITC resulting in $3 million of ITCs. On January 1, 2023, Solar Partnership Co. plans to sell all of the ITCs from the project and anticipates receiving 92 cents per eligible $1 ITC (or $2,760,000). All of the ITCs are sold on June 30, 2023 for 90 cents per eligible $1 ITC (or $2,700,000).
| Entry to Record Costs to Construction in Progress (CIP) | |
|---|---|
| Dr. CIP | Cr. Cash /AP |
| $XXm | $XXm |
Costs will be accumulated in CIP as the project is being constructed.
| Entry to Move the Completed Project Into Service on January 1, 2023 | |
|---|---|
| Dr. Property, Plant, & Equipment | Cr. CIP |
| $10m | $10m |
When the project is complete, an entry will be made to move the accumulated balance from CIP to property, plant, and equipment (“PPE”).
| Entry to Record the ITC at Fair Value on January 1, 2023 | |
|---|---|
| Dr. Transferable Tax Credit Asset | Cr. Property, Plant, & Equipment |
| $2.76m | $2.76m |
Under IAS 20, the ITC needs to be recorded at its fair value when the partnership is reasonably certain that they have complied with the conditions needed to receive the credit. Typically, this would offset the asset or could also be recorded as deferred income.
| Entry to Record Depreciation Expense for Calendar Year 2023 | |
|---|---|
| Dr. Depreciation Expense | Cr. Accumulated Depreciation |
| $289.6k | $289.6k |
This is calculated as PPE of $10m reduced by the fair value of the ITC of $2.76m divided by the estimated useful life of 25 years ($10m - $2.76m = $7.24m/25 years = $289.6k). This entry would continue each year through the rest of the useful life, even after the tax credit is sold. This results in the benefit of the tax credit transfer being recognized through reduced depreciation expense or as other income if the deferred income approach is used instead of reducing PPE.
| To Record the Sale of the ITCs on June 30, 2023 | ||
|---|---|---|
| Dr. Cash | Dr. Loss on Sale | Cr. Transferable Tax Credit Asset |
| $2.70m | $0.06m | $2.76m |
Any gain or loss on the actual sale of the ITC is recognized in the income statement at the time of the sale.
If you or your organization needs help with the accounting for the transfer of ITCs under the IRA, or you have other questions related to the renewable energy provisions in the IRA, please reach out to a renewable energy professional at FORVIS.