How to due diligence Section 48 investment tax credits
This due diligence checklist and documentation guide gives tax credit buyers, sellers, and their respective advisors a set of shared expectations on the required analysis and documentation for §48 investment tax credits.
Executive summary
Transferable tax credits are sold at a discount to face value, providing attractive financial benefits to corporate investors. They are not without risk, however, and tax credit buyers should have a clear sense of how to identify, track, and mitigate relevant risks.
This due diligence checklist and documentation guide gives tax credit buyers, sellers, and their respective advisors a set of shared expectations on the required analysis and documentation for §48 investment tax credits.
To download a PDF version of this guide, please visit our resources page.
Jump to a due diligence category
- Transaction overview
- Major deal participants
- Seller diligence
- Qualification
- Structure
- Recapture (qualified energy facility, change in ownership)
- Prevailing wage and apprenticeship requirements (compliance, exemption)
- Bonus credits (domestic content, energy community, low-income community)
- Tax credit insurance
Transaction overview
The transaction overview should include an overall description of the transaction, including:
- Brief description of sponsor
- Technology
- Project size in MW AC, location, and description
- Placed in service (PIS) date
- Eligible cost basis
- Resulting ITC credit amount
- Description of tax credit percentage, including bonus credit adders and compliance with, or exemption from, prevailing wage and apprenticeship requirements
- Details on how the project is financed
Major deal participants
Tax credit transfers involve a range of stakeholders on the buy- and sell-sides, all of whom should be memorialized for reference during the five-year recapture period.
Seller diligence
Qualification
Buyer should validate that the Project qualifies for the §48tax credit. Buyer should ensure that the Project qualifies as energy property,the proper cost basis is used, and that the Project was placed in service inthe appropriate tax year.
Structure
Buyer should validate that Seller is an eligible transferor,and that the Seller’s underlying legal structure will be respected by the IRS.
Recapture
To avoid recapture, a §48 ITC requires that (1) the property remains qualified energy property for five years and (2) there is no change in ownership of the property for five years. If a project fails to meet these requirements, the IRS will recapture the unvested portion of the ITC.
The ITC vests equally over a five-year period, meaning 20% of the total ITCs claimed will vest on each anniversary of Project’s placed in service date.
Qualified energy facility
A property can cease to be qualified energy property when anasset is disposed of, or otherwise ceases to be investment credit property tothe eligible taxpayer during the recapture period. For example, the asset is:
- Destroyed and not rebuilt and placed back inservice
- Abandoned
- Repurposed to sell something other thanelectricity derived from the qualified generation asset
Key risk mitigation measures include sufficient property andcasualty insurance, adequate site control and interconnection rights, andidentification of alternatives in the event of an Offtaker default.
Change in ownership
A change in ownership can occur if the project owner transfers its ownership of the facility during the five-year recapture period. If a lender has a collateral interest in the project company, a foreclosure can trigger recapture due to change in ownership.
Key risk mitigation measures include a forbearance agreement with lenders, structuring the debt in a way that foreclosure will not trigger a recapture, and indemnification from the seller.
Prevailing wage and apprenticeship requirements
Buyer should validate that the Project is exempt from, or compliant with, prevailing wage and apprenticeship requirements. Prevailingwage rules require that certain workers are paid a minimum prevailing wages pecified by the U.S. Department of Labor during the construction of a facility or property, and during alteration or repair of a facility or property for a certain number of years after the project is placed in service.
Buyers should require proper documentation that the correct wage was paid.
Exempt from PWA
Compliant with PWA
Bonus credits
If a Project claims a bonus credit adder (domestic content, low-income community, or energy community), the Buyer should substantiate that the Project qualifies for the relevant bonus credit adder.
Domestic content
Energy community
Low-income community
Tax credit insurance
If a Seller is unable to offer an indemnity from a creditworthy guarantor, tax credit insurance is commonly purchased to provide additional risk mitigation in the event of a disallowance or recapture of credits.
There is a robust market for tax credit insurance, which has been utilized on tax equity transactions for over a decade. Tax Credit Insurance Brokers can help place insurance with a wide selection of investment-grade insurance carriers.
Download Reunion's Section 48 ITC due diligence guide
To download Reunion's Section 48 due diligence guide in PDF format, please visit our resources page.
Related Articles
The Inflation Reduction Act of 2022 (IRA) greatly expanded energy-related federal income tax credits and created Internal Revenue Code Section 6418, which allows eligible taxpayers to transfer, or sell, certain clean energy tax credits to unrelated parties for cash.
One key area of due diligence when purchasing a tax credit is to ensure that the project complies with prevailing wage and apprenticeship requirements (PWA), which the IRA introduced to encourage a robust market for well-paying clean energy jobs.
Clean energy projects that comply with PWA requirements receive a five-times multiplier on the value of tax credits. If a tax credit buyer purchases a credit that later is found not to comply with PWA requirements, the buyer will face a recapture of the increased tax credit amount.
Buyers of tax credits should understand PWA requirements and the documentation required to ensure compliance. Buyers should also mitigate the risk of recapture due to PWA noncompliance with careful due diligence, contractual protections (including provisions requiring the tax credit seller to compensate the buyer for PWA noncompliance), and tax credit insurance.
How PWA applies to each credit type
All but one of the IRA’s eleven transferable tax credits are subject to PWA requirements; the exception is the Section 45X advanced manufacturing production credit (AMPC). The following table shows how long PWA compliance is required for each credit.
Projects that comply with PWA requirements receive a tax credit five times greater than non-PWA-compliant projects. For example, a solar project with a $100 million cost basis qualifies for a base tax credit amount of $6 million (assuming a Section 48 ITC). If the project meets PWA compliance, the tax credit amount increases to $30 million.
If a tax credit buyer purchases a credit that later is determined not to comply with PWA requirements, then the Internal Revenue Service will recapture the PWA multiplier portion of the credits, which is equivalent to eighty percent of the tax credit value — for example, $24 million of a $30 million credit. For Section 48 ITCs, the recapture is applied to the unvested portion of the credit (the ITC vests twenty percent annually over a five-year period).
As a result, buyers of tax credits must perform proper diligence on projects to ensure that the project will not later be found to fail to comply with PWA requirements.
Summary of PWA requirements
Prevailing wage requirements
Prevailing wage rules require that certain workers be paid a minimum prevailing wage specified by the US Department of Labor (DOL). The DOL publishes a list of prevailing wages on www.sam.gov according to geographic location, labor classification, and type of construction. It is also important to use the correct wage determination based on timing of work, which is primarily driven by when construction begins.
If no applicable published wage rate is available, the taxpayer or project developer must request a supplemental wage determination from the DOL.
Apprenticeship requirements
The apprenticeship rules require that a certain percentage of labor hours during construction, alteration, or repair for a project be performed by a qualified apprentice. The minimum percentage of hours that must be performed by qualified apprentices is:
- 12.5% for projects that began construction in 2023
- 15.0% for projects that begin construction in 2024 or later
Two exceptions to PWA compliance
The IRA includes two general exceptions to PWA requirements — the “beginning of construction” exception and the “one megawatt” exception. Projects that meet one of these exceptions receive the five-times credit multiplier without necessarily paying prevailing wages and employing qualified apprentices. Specifically:
- Beginning of construction: Projects that began construction before January 29, 2023, are generally exempt from the wage and apprenticeship rules, except for credits under Sections 48C and 45Z
- One megawatt: Projects under Sections 45 and 48 (and their replacements under Sections 45Y and 48E) are exempt from PWA if the maximum net output is less than one megawatt or the capacity of electrical or equivalent thermal storage is less than one megawatt
PWA information developers should collect and maintain
In its August 2023 guidance, the Treasury provided a list of required and recommended documentation for PWA compliance. All documentation should cover every person working on the project, including contractors and subcontractors. Subcontractors may be several companies removed from the actual sponsor of the project.
Required PWA information
According to the IRS guidance from August 2023, PWA documentation must include “payroll records for each laborer and mechanic (including each qualified apprentice) employed by the taxpayer, contractor, or subcontractor employed.”
Recommended PWA information
The IRS also recommends collecting additional documentation. Nine of the recommended items relate to wages — including the name, social security number, address, and email address for each laborer and mechanic — and five items relate to apprentices. Buyers should require this optional documentation, which can be found in Proposed Regulations Section 1.45-12(b) and (c).
Additionally, the PWA’s proposed labor requirements have significant overlap with the Davis- Bacon Act — a nearly century-old federal law. Some project developers document certified payroll, a practice required for federal projects subject to Davis-Bacon rules, although not required under the IRA. Each employee on the certified payroll must receive weekly payment for work performed and must have their legal name, address, correct job classification, rate of prevailing wage pay, daily hours worked, weekly hours worked, and amount paid clearly recorded on the required certified payroll report. Other project developers use the certified payroll form, WH-347, when compiling and maintaining payroll records.
Opportunity to cure if a project fails to comply
If a clean energy project claims an increased PWA credit value and the IRS later determines the project did not meet PWA requirements, the tax credit is not automatically reduced to the base rate. A deficiency can be cured within 180 days after the IRS identifies a failure.
The seller of the tax credit has a strong incentive to cure any PWA issues, as it typically signs an indemnity to compensate the buyer in the event of a recapture of tax credits. The seller is also closer to the underlying compliance issue. That said, the buyer should require the seller to provide notification of any failure to meet PWA requirements; the buyer may want to step in and make penalty payments on behalf of the seller if there is substantial doubt as to whether the seller will make the cure.
Requirements for curing prevailing wage deficiencies
To cure prevailing wage defects, the taxpayer or project developer must:
- Pay the affected laborers or mechanics the difference between what they were paid and the amount they were required to have been paid (multiplied by three for intentional disregard), plus interest at the federal short-term rate (as defined in IRC Section 6621) plus six percent; and
- Pay a penalty to the IRS of $5,000 (or $10,000 for intentional disregard) for each laborer or mechanic who was not paid at the prevailing wage rate during the year
Requirements for curing apprenticeship deficiencies
To cure a failure to meet the apprenticeship requirements, project developers must pay a penalty of $50 multiplied by the total labor hours for which the apprenticeship requirements were not met. The amount of the penalty with respect to the apprenticeship requirements is also increased to $500 per labor hour if the IRS determines the failure was due to intentional disregard.
Buyers have several tools to mitigate risk of PWA noncompliance
Buyers should proactively manage risk concerning PWA compliance. Buyers have three primary risk management tools at their disposal:
- Comprehensive due diligence
- Properly structured tax credit transfer agreement (TCTA)
- Tax credit insurance
Comprehensive due diligence
Proper and comprehensive due diligence is critical for tax credit purchasers.
Project developers currently document PWA in a variety of ways, from manual capture in spreadsheets to certifi ed payroll systems to the use of third-party consultants.
Buyers should understand the process by which PWA information is tracked so they can reconstruct payment records in the event of an IRS challenge. Each contractor and subcontractor should have a system in place to document payroll. In addition, proper records should be kept so workers who were underpaid can be located and compensated to cure any failure to meet PWA requirements.
In the case of the Section 48 ITC, the seller should also provide any information or compliance reports the IRS requires during the five-year recapture period.
Properly structured TCTA
Buyers bear the risk of any reduction in tax credit amount due to noncompliance with PWA. Buyers should ensure that the TCTA includes sufficient indemnity from the seller in the event of PWA noncompliance. The indemnity should make the buyer economically whole, including the cost of any penalties.
In addition, the TCTA should include several other clauses that protect tax credit buyers:
- Representations and warranties: The seller has complied with or is exempt from all recordkeeping requirements relating to the PWA requirements
- Indemnification: The seller’s indemnification obligations include any interest or penalties the IRS may impose because of PWA noncompliance
- Conditions precedent to closing: The seller must furnish evidence the project has complied with PWA requirements
- Post-closing obligations: The seller will comply with all laws and regulations required to qualify for and receive the PWA multiplier, including making the necessary filings, registrations, and elections with the IRS
Purchase tax credit insurance
Finally, tax credit insurance is available to mitigate the risk of noncompliance with PWA requirements. Tax credit insurance is recommended if the buyer has doubts about the ability of the seller to fulfill its indemnity obligation in the event of an IRS challenge. Tax credit insurance can be sized to make the buyer whole in the event the IRA imposes a penalty.
Conclusion
For corporate taxpayers, transferable tax credits represent a new opportunity to reduce federal tax liabilities and achieve a strong risk-adjusted return while providing much-needed capital to clean energy projects. However, buyers are responsible for financial penalties imposed by the IRS due to noncompliance with PWA requirements.
Tax credit buyers should proactively mitigate the risk of penalties with careful due diligence, contractual protections, and tax credit insurance, ensuring that they preserve the full financial benefi t of their tax credit purchase.
The IRA created a new clean energy tax credit, the §45X AMPC
The Inflation Reduction Act of 2022 introduced a new class of production tax credit — the §45X advanced manufacturing production credit (AMPC). The credit is for eligible components produced and sold after December 31, 2022 and is transferable under §6418.
The §45X tax credit is generated via the production and sale of:
- Sustainable energy components: Five categories of eligible sustainable energy components including solar modules, battery cells, or wind blades, nacelles, or towers
- Critical minerals: 50 applicable critical minerals that attain a specified purity level
A list of eligible components, critical minerals, and related tax credit amounts is included below.
§45X transfers have taken off since the IRS issued guidance in December 2023
In December 2023, the Department of the Treasury released proposed regulations on §45X tax credits, which opened the door for transactions to begin.
Notably, Fiserv (NYSE: FI) agreed to purchase $700M in §45X tax credits from First Solar (NASDAQ: FSLR) at a price of $0.96 per dollar of credit, resulting in $28M of tax savings for the 2023 tax year. The public announcement of a large-scale transaction has led to significant interest from corporate buyers in §45X tax credits.
Key characteristics of §45X AMPCs
Generated over time
§45X AMCPs are generated on a rolling basis from the (i) production and sale of eligible components or the (ii) conversion of critical minerals to a specific purity level. As we'll discuss below, this opens the door for buyers to negotiate quarterly or monthly payment terms.
No recapture risk or prevailing wage and apprenticeship requirement
There is no recapture or prevailing wage and apprenticeship (PWA) provision, reducing risk associated with §45X tax credits.
Eligible for direct pay or transfer
As with §45Q and §45V credits, generators of §45X credits may elect to be treated as an “applicable entity” for the limited purpose of making an elective payment election, also known as direct pay.
Careful consideration should take place before electing in or out of direct pay for §45X credits. The election is rigid in that there are no partial elections:
- The election applies to all eligible credits from the applicable facility, and
- The election applies to the entire taxable year for which the election was made and all subsequent taxable years ending before January 1, 2033
Additionally, an electing taxpayer may file an irrevocable election to revoke the elective payment, but the revocation applies to the entire taxable year in which the election to revoke takes place and all subsequent taxable years remaining before January 1, 2033.
In short, AMPC generators may elect to take five years of direct pay with the IRS or transfer the credits to another taxpayer, and the ability to do both is significantly limited.
Commercial guidelines for buyers of transferred §45X tax credits
Sellers
Sellers of §45X tax credits range from large, multinational companies to smaller, domestic producers. Tax credit buyers may require sellers to procure tax credit insurance if there is uncertainty around their longevity and/or ability to cover indemnities relating to the sale of credits.
"Unaffiliated third party" buyers
In order to generate AMPCs from the production and sale of eligible components, buyers of manufactured components must be unaffiliated third parties unless a related party election has been made under §45X(a)(3)(B).
All sales must be for “productive purposes” and not solely to claim the §45X tax credit.
Pricing
In Q1 2024, median pricing to buyers ranged from $0.91 to $0.95 for single-year 45X credits. The relatively high pricing reflects the lower risk profile of AMPCs compared to investment tax credits (ITCs).
Drivers of larger price discounts include smaller transaction sizes, less established sellers, and forward contracts for credits that have not yet been generated.
Payment terms
AMPCs are sold in arrears of generation. Unless the AMPCs are sold in a single closing, most sellers will accept quarterly or monthly payment terms, allowing buyers to recognize the value of the credit before issuing payment to sellers.
Due diligence checklist for §45X tax credits
While §45X credits are not subject to PWA requirements and do not carry the same recapture or basis-related qualification risks as §48 ITCs, they do carry additional qualification risks that are absent from other, power generation-related tax credits such as the §45 production tax credit (PTC).
Buyers and their advisors should conduct due diligence on several core aspects of §45X tax credit qualification to avoid a situation where credits are improperly accounted for and subsequently disqualified — a risk that flows through to the buyer in a transferability transaction.
Eligible components and related §45X tax credit amounts
The table below shows the eligible components that qualify for §45X credits as well as the amount of tax credit.
Subject to a four-year phase-out (except for critical minerals)
With the exception of critical minerals, the amount of credit begins phasing out for sales occurring after December 31, 2029. As a result, the amount of tax credit is 75% for components sold during calendar year 2030, 50% for components sold during calendar year 2031, 25% for components sold during calendar year 2032, and 0% thereafter.
Learn more
Reunion is actively transferring §45X tax credits from a variety of clean energy manufacturers. To learn more about sourcing, diligencing, and purchasing §45X AMPCs, please contact Reunion's experienced transactions team.
2023, the first full year of the Inflation Reduction Act, is officially behind us. As year-end approached, transactions closed in lockstep with the release of further IRS guidance and other market-enabling milestones.
With the turn of the calendar, we wanted to share our 2023 pricing observations and 2024 pricing predictions.
Overview of tax credit transfer pricing
Transferable tax credits are sold at a discount per $1.00 of credit, and the discount is the primary incentive for a buyer to enter into a tax credit transaction. A corporation, for example, buying credits for $0.90 would pay $90M in cash in exchange for $100M in tax credits. The company would realize $10M of savings, which is not treated as gross income and, therefore, not subject to taxes.
The net price the seller receives for the credit is typically the buyer’s purchase price less the cost of tax credit insurance and transaction fees (e.g., fees paid to a platform or facilitator such as Reunion).
Looking back on 2023 pricing
The market for transferable tax credits remains nascent, as transactions started in earnest following Treasury guidance on June 14, 2023. We have found that offers (and closed transactions) for 2023 tax-year credits are within fairly narrow pricing bands based on risk/complexity.
Across these pricing bands, projects with more scale have tended to drive smaller discounts.
§45 production tax credits (PTCs)
§45 PTCs are the simplest transaction to execute, as the credit is straightforward to validate. Buyers commonly review production reports and related documents to confirm that electricity was produced from an eligible project type and sold to an unrelated third party. Importantly, §45 PTCs do not carry recapture risk.
Current-year PTCs have been trading in the $0.94 to $0.95 range. Buyers who have committed to paying for PTCs that will be generated in future tax years have received larger discounts.
§48 investment tax credits (ITCs)
§48 ITCs carry more complexity. The buyer will need to validate the cost basis used to calculate the ITC as well as the tax year that the project was placed in service:
- Cost basis: If the cost basis has not been properly calculated, the credit can be subject to disallowance by the IRS
- Placed-in-service date: The project must be placed in service in the desired tax year; if a project is placed into service in a later-than-expected tax year, the tax credits can be carried back up to three years but the process is not straightforward
§48 ITCs are subject to recapture rules, which require that (1) the property remains a qualified energy facility for five years, and (2) there is no change in ownership for five years. If these conditions are not met, the IRS will recapture the unvested portion of the ITC (the ITC vests equally over a five-year period).
2023 summary pricing
The discount is only one financial metric. Many buyers are also interested in timing of cash flows
While the discount is often the first question that we receive about tax credit pricing, it is not the only metric to evaluate the financial return of a tax credit transfer.
The timing of cash flows from a tax credit transfer is also important to buyers. Treasury’s June 2023 guidance clearly states that a “transferee taxpayer [i.e., a tax credit purchaser] may also take into account a specified credit portion that it has purchased, or intends to purchase, when calculating its estimated tax payments.”
Below are several examples of how timing of a tax credit purchase can impact returns (assuming buyers purchase credits for $0.90):
Finally, buyers commonly request to delay payments for a tax credit transfer to line up with their quarterly estimated tax payments. This is a key negotiation point, as sellers prefer to get paid as soon as possible after credits are generated.
Going forward, we expect delayed payment terms to result in a smaller headline discount for the buyer, since the seller will want to be compensated for their cost of capital.
In September 2023, we wrote a detailed discussion on buyer returns and also made a returns calculator available for download.
Looking forward to 2024 pricing
As we consider macro-level tax credit pricing in 2024, two major themes come to mind: increased credit supply and market bifurcation. The former is an emerging trend, while the latter extends from 2023.
Increased tax credit supply
Early analysts predicted that discounts would shrink as the market matures. We do not believe this is a foregone conclusion.
There is a significant increase in supply of clean energy tax credits for the 2024 tax year; Reunion’s digital platform already lists over $3 billion in tax credit opportunities for the 2024 tax year. This increased volume of tax credits looking for buyers will put downward pressure on pricing, at least until buyer demand grows commensurately.
In contrast, the supply of 2023 tax year credits was constrained, with a relatively small number of projects for buyers to invest in.
Continued market bifurcation
Heading into 2024, we believe that the market will bifurcate: certain credits will demand premium pricing while other credits (e.g., uninsured ITCs without an indemnity from a creditworthy guarantor) will need to offer a deep discount and/or novel ways to mitigate risk.
Common project types that will garner premium pricing include:
- §45 PTCs from solar and wind with an indemnity from a creditworthy guarantor or tax credit insurance. Certain §45X credits from advanced manufacturers will trade at a premium, if the size of the credit is significant and the seller provides a creditworthy guarantee or tax credit insurance
- §48 ITCs from sizable solar or battery projects (larger transaction sizes will demand a premium price), with an indemnity from a creditworthy guarantor or tax credit insurance
- §48 ITCs from solar or battery projects sold out of tax equity partnerships with experienced sponsors and tax equity investors
2024 summary market drivers
Overall, our view is that risk/complexity and scale will be the two main drivers of pricing. Projects that present buyers with lower risk and greater scale will, ultimately, enjoy higher pricing.
How Reunion helps
The Reunion team is available to meet with buyers looking to purchase 2023 or 2024 tax-year credits, and is also available to answer questions for those looking to learn more about the rapidly growing tax credit transfer market.
Please find us on LinkedIn or email us at info@reunioninfra.com.
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