U.S. Treasury and OECD Lay Groundwork for Selling Clean Energy Tax Credits
The Situation: With the Inflation Reduction Act of 2022 (the "IRA"), Congress created new tax credits and expanded several others to encourage U.S. taxpayers to invest in clean energy and carbon reduction projects. Congress also provided a framework for taxpayers to buy and sell many of these credits, paving the way for developers to turn these tax credits into cash.
The Development: Proposed regulations issued by the Internal Revenue Service ("IRS") and Treasury Department ("Treasury") provide practical guidance on the transferability of these tax credits. Also, guidance from the Organisation for Economic Co-operation and Development ("OECD") clarifies how multinational enterprises that buy and sell IRA tax credits will be taxed under the Global Anti-Base Erosion ("GloBE") Model Rules, commonly referred to as "Pillar Two."
Looking Ahead: In light of this new guidance, taxpayers eager to enter this new marketplace can now do so with confidence that these new tax credit sales will be respected and that they will be able to accurately calculate the applicable tax implications (including under Pillar Two) beforehand. This should help advance the development of this new tax credit market.
Proposed Regulations on Buying and Selling IRA Tax Credits
Section 6418 of the Internal Revenue Code allows taxpayers to elect to transfer all or a portion of certain IRA tax credits to an unrelated buyer for cash. Buyers may apply the credits to reduce their tax liability for the year in which the credit arose or carry the credits back or forward to a different taxable year.
Proposed regulations released on June 14, 2023, provide guidance to taxpayers on several aspects of the transfer election, including how Treasury expects the market for tax credits to operate:
- U.S. dollars are the only form of consideration allowed.
- The transfer may be jeopardized if a buyer pays the consideration earlier than the first day of the seller's taxable year in which the credit arises or later than the due date for the seller's federal tax return. A buyer may contractually commit to purchase credits in advance, so long as cash payments are made within this window.
- A credit may be transferred only once. However, Treasury acknowledged that brokers may facilitate a deal without violating this rule, so long as the broker does not acquire beneficial ownership of the credit.
- Individuals are not expected to participate in this market, as the proposed regulations would generally not permit purchased credits to offset taxes on wage income or most types of an individual's investment income.
- Taxpayers that acquire credits indirectly (e.g., as a partner in a partnership, from an inverted lease or from disposing, or utilizing qualified carbon oxide without owning the relevant carbon capture equipment) are not eligible to sell credits.
- Where a disregarded entity directly owns property generating the applicable tax credit, the sole regarded owner of the disregarded entity may make the election to transfer such tax credit.
- Before making any election to transfer credits, sellers are required to register themselves and their projects with the IRS through an electronic portal.
The proposed regulations also clarify how the credits will be treated in the hands of buyers:
- Buyers will not be taxed on any value received as a result of a discount to the face amount of the credit.
- Buyers that are partnerships may generally allocate the credits to their partners (excluding partners that enter the partnership after the purchase).
- Buyers are generally liable for recapture of investment tax credits (e.g., because the seller disposes of a project before the full vesting period or because a project ceases to be eligible property) but may negotiate for indemnification from sellers.
- Buyers can take into account anticipated tax credit purchases in calculating their estimated taxes.
Taxpayers may generally rely on the proposed regulations for taxable years beginning in 2023.
OECD Guidance on Transferable Tax Credits
Under the GloBE Model Rules, a jurisdiction may impose a "top-up" tax on the parent of a multinational enterprise to the extent the effective tax rate on income of the enterprise in any foreign jurisdiction is less than 15%.
There are two ways to treat tax credits under the GloBE Model Rules. First, tax credits may be treated as a reduction of the enterprise's "covered taxes" (i.e., as a reduction in the numerator of the effective tax rate calculation). Alternatively, tax credits may be treated as an item of income (i.e., as an increase in the denominator). Taxpayers prefer the latter treatment of tax credits because it results in a smaller reduction in the effective tax rate (making a top-up tax less likely).
On July 17, 2023, the OECD released guidance on how to treat transferable tax credits. The guidance distinguishes between two types of tax credits:
- "Marketable Transferable Tax Credits" are treated as income for GloBE purposes. This includes any legally transferable tax credit, so long as it is purchased and sold (or may be purchased and sold in the market) for at least 80% of the net present value of the credit. IRA tax credits appear to be Marketable Transferable Tax Credits for the originator of the credit (whether or not the originator sells them).
- "Non-Marketable Transferable Tax Credits" are treated as a reduction in covered taxes. This includes any transferable tax credit that is not a Marketable Transferable Tax Credit. IRA tax credits appear to be Non-Marketable Transferable Tax Credits for the transferee of the credit. However, the amount of the reduction is limited to the difference between the price paid for the credit and the face amount of the credit.
The GloBE Model Rules provide a safe harbor from certain top-up taxes for jurisdictions that have a corporate income tax rate of 20% or greater (e.g., such as the United States, which currently has a 21% corporate income tax rate), generally applicable to fiscal years that end before December 31, 2026. Under the new temporary safe harbor, Pillar Two generally is not applicable to the U.S. activities of U.S. parented multinational enterprises, at least until the next presidential election and the following congressional session. This relieves significant pressure on the classification of U.S. tax credits for Pillar Two purposes for the near term.
Three Key Takeaways
- The Treasury guidance on selling IRA tax credits provides taxpayers with much needed clarity while also setting limitations on how credits can be sold, by whom they can be sold, and when they can be sold.
- Generally, the determination as to whether a tax credit is a Marketable Transferable Tax Credit or a Non- Marketable Transferable Tax Credit for purposes of Pillar Two can significantly impact the tax treatment of the applicable multinational enterprise.
- Under new OECD guidance, transferable tax credits generally appear to be afforded favorable treatment for sellers for purposes of the GloBE Model Rules—treated as an item of income rather than a reduction in taxes, which has a smaller impact on effective tax rate.
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