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Solar Energy Industry Association (SEIA) Tax Equity Conference Brief
I recently attended the Solar Energy Industry Association‘s (SEIA) Finance and Tax Seminar in New York. The subject matter in this event delved into issues related to tax equity finance. Each panel session was moderated by a tax attorney or an accountant, and most of the content of the sessions consisted of technical tax law.
To place the discipline into context, one speaker noted that the tax equity renewables investing deal volume in 2018 was $2-3B for solar and $9B for wind, and the number of tax equity participants is roughly only 25-35 large corporations. So unless there are changes to the tax code that would widen the range of entities that could benefit from tax equity investing, the pool of investors is not likely to broaden parabolically. Total investments in the US for renewables in 2018 was estimated by Bloomberg New Energy Finance at $43B, and globally totaled $300B total for all clean energy investments, including equity raising by companies in smart grid, digital energy, energy storage and electric vehicle. Estimates from numerous NGO’s contend that the rate of investment needed to transition rapidly enough to bend the GHG temperature curves is more like $1-2Tr per year. So the scale of tax equity investment, although substantial and growing, is estimated to be less than 20% of the build rate needed to deliver 80% renewable electricity per various transition targets proposed by various states, the Green New Deal, & others.
The keynote session was moderated by a principal from Novogradac, an accounting firm with a large renewables practice, who prefaced with a very brief overview of the mechanics of the 3 primary partnership structures commonly used in the industry: the partnership “Flip” structure, Sale Leasebacks & Inverted Leases. A second session titled “Solar Finance 101” led by an attorney from Norton, Rose, Fulbright was provided specifically to elaborate on the structures.
In a Partnership Flip the General Partner (Sponsor/developer) starts by holding 1% of equity, and the Tax Equity Investor (TEI) is the Limited Partner holding 99%. A flip in the ratio to GP 95% / LP 5% is triggered either by reaching a target yield (usually 5-7 yrs), or a date certain (6-8 years). The target ROI for the TEI in a yield-based version is in the range of 6.5%, earned from Investment Tax Credits against prior losses & development costs, and some portion of operating cash flow. The fixed-term version requires different terms for the investors to achieve the desired yield, and usually extends 6-8 years. The fixed flip leaves as much cash as possible for the sponsor, and pays the TEI’s cash as a 2% preferred distribution.
In the 101 session, the main challenge was identified as: how to get a step up in tax basis so that benefits are calculated on Fair Market Value rather than on Cost or DCF (discounted cash flow). She cited 3 court cases that will be adjudicating: a) the allowable standard for this valuation, b) whether developer fees should be limited to 12-18%, and c) whether use of DCF with a low discount rate that artificially raises value should be disallowed as a disguised sale. The test imposed by the IRS would disallow the ITC claim if the DCF is the same after the end of the PPA term, DCF should be different in the merchant period, usually expected to be 7.5% to compensate for the variability risks of merchant pricing.
“Absorption” was the other key element discussed throughout the conference, and is one of the more complex aspects of partnership taxation. The Capital Account for each partner documents what each has contributed and is allowed to take out in tax benefits, and cannot drop below zero. “Tax efficiency” characterizes whether the tax benefits can be fully taken by either party, or remain partially unclaimed. If the TEI capital account is at risk for drawing down too much, such that the tax benefits would re-allocate back to the sponsor who also could not use them, then the remedy is often a Deficit Restoration Obligation (DRO), in which the sponsor indemnifies the TEI.