How was Sol Systems affected by tax reform?
Sol Systems is a limited liability company, and currently we do not operate internationally. As a result, some issues that are commonly discussed among tax professionals regarding BEAT in the Tax Cuts and Jobs Act do not directly impact us. Given that renewable energy projects are classified as manufacturers in the new code, we are primarily focused on the interest expense limitations provision of the TCJA – 30% of adjusted taxable income (ATI) for net interest expense deductions.
Another significant issue that came out of the new tax code for us was a reduction of the overall corporate tax rate that in turn reduced the tax appetite of our corporate clients. Our structured finance team had to adjust return profiles of our tax equity and development partners via revising the mix of benefit allocations in tax equity structures. Also, some of the negative impact from the reduction in the overall corporate tax rate was offset by the increase in loss benefits due to the increase in allowable bonus depreciation. The allowable rate went up from 50% to 100% for qualified solar projects.
Additionally, we should account for a very predictable outcome of any new regulation that adds complexity. Our internal costs and time needed to file tax returns across our entities for 2018 nearly doubled from 2017.
Sol Systems relies on energy tax credits and other tax incentives as part of its business. What are the biggest issues surrounding energy tax credits, and how could that impact your business as well as other renewable energy companies?
The biggest issue surrounding energy tax credits today is the uncertainty. To step back, in December 2015, the federal government approved the extension of the solar investment tax credit (ITC), which steps down as follows: 2019 – 30%, 2020 – 26%, 2021 – 22%, 2022 and after – 10% for commercial systems only, zero for residential. The mechanics are very simple. Through 2019, the IRS will allow you to deduct 30% of the cost of installing a solar energy system from your federal taxes. The IRS allows companies to safe-harbor, or lock, the ITC rate for any project that commenced construction prior to the respective year-end and remains under construction without interruption until the project is placed in service, or to invest 5% of the eventual project cost by the respective year-end. Of course, the devil is in the details, which we will most likely be discussing during the Tax Leadership Conference on November 19.
It is worth noting here that the ITC rules for solar were not directly altered by the new tax law (TCJA). There is a separate set of tax legislation that is currently under review. The Renewable Energy Extension Act of 2019 calls for the extension of the 30% tax credits for the next five years. It is very hard to predict the destiny of this proposed extension, and all the companies that anticipate being impacted need to be ready for either scenario.
Let’s not forget that the ITC federal incentive program was and remains one of the largest driving forces behind the solar industry in the U.S. As a result, any change related to ITC will produce a massive ripple effect on operations and profitability across the industry and will overflow into adjacent industries.
So far, like many others in the industry, Sol Systems is working on safe-harboring projects while evaluating the potential impact of the ITC Extension Act. Clearly, additional workload reduces our efficiency and increases internal costs of our business.
How do state energy tax credits factor into your business? What is happening on the state tax side that has you concerned, or has you encouraged, when developing new or managing existing projects?
Tax legislation, policies, power market structures, and incentives that surround the solar landscape from state to state vary drastically and change on an ongoing basis. Some states, such as California, North Carolina, Texas, Illinois, Massachusetts, etc., are far ahead of the curve on the national scale regarding solar incentives and policies. At Sol Systems we spend a lot of time tracking these changes, as they impact all of our businesses.
In general, we do not focus on state tax credits specifically for multiple reasons. One of them is the fact that not all of the tax equity investors we work with have tax appetite in states where solar systems are located. Also, in many cases, benefits derived from state tax credits are incremental to the overall return profile.
For example, the continued acceleration of aggressive renewable portfolio standards (RPS) has broad and significant impacts on solar regionally, since RPS legislation generally enables both in-state and out-of-state development. More aggressive RPS standards drive up prices of the Solar Renewable Energy Credits (SRECs), shifting the focus from valuation of state tax incentives, where available, to SREC production volume and price curves in modeling the returns.