Crux Connects: Sam Kamyans of Kirkland & Ellis on safe harbor, change in law, and tax law changes

Welcome to Crux Connects, Crux’s interview series with energy finance experts. Tax reform is going to be a major policy priority for the incoming administration. That is raising a lot of questions about the current system of energy tax credits. In this installment, Crux General Counsel Jake Wolf talks with Sam Kamyans, a partner in the Tax Practice Group at Kirkland & Ellis, where he specializes in tax-driven transactions for the investing, financing, and acquisition of energy projects, and Katie Bays, policy and research strategist at Crux.

They try to understand potential impacts of tax reform in the next administration on energy tax credits, including what we can learn from the history of the investment tax credit (ITC) and production tax credit (PTC). They also explore safe harboring and potential impacts on transaction structures that aim to monetize these credits.

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Transcript

Jake Wolf: Let's start with the history of the ITC and the PTC. When were they established? How have they been extended or sunsetted over the years? And in particular, please highlight what the political makeup has been during these various steps.

‍Sam Kamyans: The investment tax credits have really been a creature of statute since, I believe, the 1950s or 60s. There are still examples in the regulations that talk about grain elevators and technologies that today we don't view as innovative or really cutting edge. At the time, the investment tax credit was intended to spur investment in areas that, as a policy matter, we wanted to support. And it's been clearly very successful, kind of fast forwarding from that period. It was in the early 90s when the PTC was established for wind. Over time, additional technologies began to creep into the statute. Again, this is primarily for energy policy and to spur development in the renewable sector. From that PTC for wind, we started slowly seeing solar come in, geothermal was becoming more popular, and a number of the other technologies that we have today. Historically, nowhere near on the scale we've had under the Inflation Reduction Act (IRA) with the sheer array of technologies that are available for credits.

But again, this is kind of the end point of where we've gotten by having started with the credits. That's kind of a brief history of where we started and where we are.

From a technology standpoint, I think one item that is important in the credit history is that they've been subject to sunset numerous times, meaning that the credits would either expire or slowly phase down. Presumably, the intention there is that the technologies have matured, costs have come down, and federal subsidies are no longer necessary. In the renewables context, that hadn't happened as quickly as folks had envisioned. There's been a concern that's been shared and accepted among both Republican and Democratic administrations where they view the sunset as being a net negative to the industry. And these are most starkly seen in the late 2010s when the wind credit was slowly phasing down and the solar credit was slowly phasing down and expiring. Both the Trump administration and the Obama administration on a bipartisan basis have extended these credits and prevented their sunsetting. The IRA stands out in that it's widely viewed, and rightfully so, as a Democrat-only bill due to reconciliation. But historically, on smaller-scale statutes and legislation, we have seen strong bipartisan support for a number of technologies.

JW: You talked a little bit about the history of sunsetting. Have the ITC and the PTC ever been terminated early or used as a pay-for during a reconciliation process?

SK: It's been talked about quite a bit, and in recent history, we haven't seen credits taken away as a pay-for for reconciliation. It's certainly a hot topic right now in terms of what credits can be either pulled forward or somewhat sunset in a package toward the end of next year that would allow for more room in the budget to address other areas of the administration's kind of policy list. But we haven't seen a direct correlation between getting rid of particular tax credits in order to pay for other priorities in a reconciliation process.

JW: Speaking of budget reconciliation, Katie Bays, I'll come over to you next. What is it, and how does it work?

Katie Bays: We can save Sam having to delve into the depths of budget reconciliation, but it's an increasingly common tool that we see Congress using when you have a fact pattern like the incoming administration will have, where they control both chambers of Congress, and they control the White House. Their control in Congress is by a narrow majority, which means that they don't have enough votes on a purely partisan basis to move legislation out of the Senate outside of the budget reconciliation process. Most people will know that passing legislation in the Senate requires a 60-vote majority or filibuster-approved majority. So you'll see the Senate move things like nominees and judges on a simple majority basis as a part of the Senate’s HR function. Senate has relaxed those filibuster rules, but the filibuster remains in place for legislation. That is, unless you use budget reconciliation.

Reconciliation allows Congress to move a legislative package with a simple majority in both chambers. Republicans will have a two- to three-seat majority in the House and about 53 seats in the Senate, subject to when Senator Rubio resigns the Senate to ostensibly take his seat in the administration and when his replacement is appointed by Governor DeSantis. Budget reconciliation is a powerful tool: changes that are enacted through that process have to have a budgetary impact, and the budget reconciliation typically affects a 10-year period of time, although not all of the tax law changes will last for that full 10-year period.

Typically, because of that budgetary requirement, which is also referred to as the Byrd Rule, we've seen budget reconciliation effectively become a tax law vehicle, and we've pretty much always seen large tax packages move this way, including the last major Republican tax package, the Tax Cuts and Jobs Act, and then of course the Democrat’s Inflation Reduction Act.

JW: That sounds fairly complicated on budget reconciliation. We've heard a lot of chatter that this is the top priority for the administration, and it will be handled quickly in the new Congress. Given what you just laid out, how quickly can something like this actually get done?

KB: Yeah, it is really complicated. And there are several procedural requirements in order to use budget reconciliation that sort of pre-stage a fight between some of the more deficit hawk members of the Republican caucus and the rest of the leadership. So for instance, when Congress is sworn in January of 2025, they will begin writing the rules for the new Congress and within those rules they'll have to write reconciliation rules. You can use reconciliation once in a fiscal year period, and you will have to decide at the beginning of the Congress do you plan to use reconciliation in both fiscal year periods, and for what, and how much additional deficit spending will that reconciliation process generate? So, these are all complicated fights.

What Republicans are doing to try to simplify this process is, from what we've heard, sending folks home with a preloaded tax package so that there are some high-level provisions, tradeoffs, cost estimates, talking points for members to go home with to allow them to come back to DC in January ready to move a set of rules and reconciliation instructions that allow them to act quickly. So, it's anyone's guess as far as how quickly they'll be able to get a bill together. We've heard lots of estimates from within the first hundred days to by Memorial Day to, you know, as late as December, so very much up in the air.

I wouldn't want to venture a guess there, but those are the kinds of things that the Republicans are trying to preload so that they're ready to go when they get back to town.

JW: Katie, Sam talked a little bit about the history of the ITC and the PTC. As we move into the reconciliation process, are there any credits or bonuses that are particularly likely to face scrutiny from Congress in the course of the tax reform process?

KB: Yeah, I would love Sam's perspective on that. The only thing I'll chime in is just in the vein of what I've already said that the incentive for identifying a provision through reconciliation, whether it's a new provision that you want to enact or a provision that you want to repeal to generate revenue, is that the juice needs to be worth the squeeze. It must have enough political support but also generate enough revenue that the leadership feels like it's worth the fight to include a provision in the overall reconciliation package. So, in the context of the IRA, be looking particularly at provisions that maybe have less robust political support but also liberate quite a lot of revenue for the government.

One of the examples of that we've hit on, I know a lot of other people have hit on, is for instance, the individual electric vehicle tax credit, which Treasury estimates to generate about $100 billion over 10 years and which has somewhat tepid support amongst some members of the Republican caucus for a variety of reasons. But yeah, I want to kick it over to Sam, if you don't mind. Do you have any additional thoughts or color that you have heard or want to chime in there?

SK: So I think I agree with what you're saying in terms of the EV credits, both in the light duty and heavy duty. The charging station credits, I think, are ones that are easy ones to kind of focus on if the goal is to open up room in the budget for other pay-fors. And I say that because, at least in our practice, we haven't seen meaningful businesses investing in the charging station. So, there isn't a whole lot of equities involved that are seeing their investments being put at risk. The way those statutes are crafted is kind of focused on smaller assets that have to be aggregated in a meaningful basis in order to really provide return.

So for a number of reasons, it's just not as popular and not worth the fight as retaining solar credits or wind credits and some of the bigger-ticket items that are out there.

JW: Sam, let's talk a little bit about timing as we move into 2025. Assuming that tax reform is passed in 2025 and it impacts certain of the credits that we've discussed, is it feasible that process could impact projects that were placed in service in 2025? Or, to put it another way, have any sort of a retroactive impact on projects that have already entered service and earned their tax credits?

SK: It's a really good question. The concern about a retroactive repeal of tax credits for projects is one that is on everyone's mind. I think from a historical perspective, we rarely, if ever see a retroactive tax law change unless it's intended to address a very abusive tax shelter, and those are typically done through the regulatory or administrative process. Then the IRS has kind of statutory authority to make things retroactive in limited circumstances. But kind of setting aside those special situations, I think the part that people can be focused on is would a 2025 retroactive repeal aid in the reconciliation process to free up budgetary room for other legislation on a, let's say, 1-1-26 basis moving forward?

And one way to think about it is if the credits for this year have already been priced into the budget and there's no net benefit to retroactively repealing them, query whether the juice is worth the squeeze. Again, it would really upset a lot of constituencies if there is a retroactive repeal, and businesses are really focused on pricing their deals based on what they are going to receive in 2025 for those projects that they're putting into the ground. I think the general consensus is that, sure, retroactive repeal is possible, but it doesn't seem to benefit the administration as much as people might want. And so, then the question is it better to focus on a go-forward change versus this retroactive repeal that's going to cause a lot of consternation, particularly in the red states that are receiving a lot of benefits from projects. For example, batteries are gaining huge popularity and are highly concentrated in Texas. There is this dynamic where there's a large constituency in a powerful state that would be in all likelihood very opposed to retroactive changes. And so sure, the specter is out there, but the likelihood should be low for those reasons. But we'll see the contours of the bill as proposals start making their way through the next administration.

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JW: So Sam, turning to the safe harbor more fully, we've talked about how a lot of these credits have expired, sunsetted in the past. And the industry has used various safe harbor tools to provide certainty and confidence in terms of construction and investment decisions. Can you talk a little bit more about the safe harbor? What enshrines it into law, what tax credits does it apply to? And just in general, how does it work?

SK: Sure. This kind of piggybacks off of the retroactive change in tax law question. One way that Congress has given taxpayers the ability to make informed judgments about their investments has been to introduce a concept that if a particular credit is scheduled to expire, a taxpayer can take certain actions to guarantee the availability of that credit so long as they satisfy the requirements of the statute. The most popular one that Congress has used is the notion of starting construction on a project. And there's no actual guidance in the statute as to what that means, so over time, IRS and Treasury have given taxpayers considerable guidelines as to how they can start work on a particular project in order to guarantee the availability of that credit. And it's evolved into two distinct tests. One is a bright line: there's a certain minimum spend that a taxpayer has to make with respect to its project prior to the statute's expiration. Another way is to actually begin work on the project, whether it's starting to dig foundations for a large wind turbine or starting work on major components within a utility-scale solar project, like a transformer or other large components of equipment. Really what the Treasury has done is provide these guidelines and give certain time limits as to when projects need to be put into the ground so that you avoid abusive situations where a taxpayer goes and hoards a lot of equipment waiting for sponsors that need the equipment in order to get the credit and then sell that equipment at a very large premium.

The IRS and Treasury have generally said if you start work and you place it in service within four years, we will respect your eligibility for the credit over the years. There's been some variation in that concept depending on the asset class. For example, carbon capture projects have six years to place their projects in service just due to the longer construction timelines for those types of equipment. And IRS during the COVID era had extended the period during which projects can be placed in service.

There's been a very strong signal from the government that we will respect the realities of whether a project may take longer or extenuating circumstances and work within the guidelines that Congress has given in order to enable projects to be placed in service. We're kind of looking at a similar dynamic in 2025.

If there's certain credits that are going to expire and those credits have start-of-construction parameters built in them, taxpayers have this continued opportunity to plan and ensure that work that they begin in 2025 will satisfy the metrics they need for the project to be profitable. That said, this is not available for all asset classes. So charging stations, electric vehicles use a place-and-service concept versus a start-of-construction concept, which takes away the ability to have long-term safe harbor.

JW: On that note, looking at related financing structures, are there particular risks around safe harbor that we'd expect investors in the capital stack to be mindful of? For instance, risks that tax equity or pref equity investors or even lenders may or may not be willing to take around projects that are seeking to be safe?

SK: It's kind of fluid right now in terms of what the risk profile is. So, before these upcoming expected changes in tax law, there was just a general belief and understanding that there wouldn't be any sort of retroactive changes in tax law this time. I think people are a bit more cautious. The risk profile was somewhat easy to work around. Going back to start of construction when you have minimum spends that all the parties are comfortable have been satisfied, all the parties can kind of manage that risk and they're able to make their investments based on that risk. When we get to kind of this next coming round, my thought is that lenders will continue to be very rigid in their risk analysis for the projects.

I think they will focus on the lowest-risk start of construction. And I say that in the context of there are certain strategies that are less accepted by the market for startup construction to work, and a lender just might not accept that risk at all. Whereas strategic investors or preferred equity investors might have a more liberal take on whether the strategy works. We might see a little bit of variation in terms of what risks lenders will take versus what the investors will take. But for the most part absent divergent fact patterns, I think most of the risk profile and what the risks will take will be concentrated kind of toward the middle-of-the-fairway-type startup construction strategies.

JW: Let's turn to tax credit transfers specifically. You know, I think universally we see a condition precedent to closing slash funding in tax credit transfer agreements (TCTAs) related to change in tax law and in some cases, proposed changes in tax law. Can you talk a little bit about those definitions and how they may or may not change, you know, moving into this new environment in 2025?

SK: At a high level, if you're a credit buyer and a project has been placed in service or is close to being placed in service, if there's been a change in tax law prior to that project getting placed in service, that raises question as to the availability of the ITC or simply repeals the ITC. The buyer has that protection that if the credit is repealed, they simply don't fund. So a condition for them paying for the credits that they've agreed to buy is that those credits are available and in existence as of the time that they're going to make their payment.

It gets a little trickier when there's a proposed change in tax law and the situation is that you get to the funding date and there's a proposed law out there that suggests there's going to be this retroactive repeal of the ITC. Setting aside the likelihood of that occurring if that law is out there, the parties are rightfully skittish about whether they'll get the benefit of their bargain. There's quite a bit of variation in terms of how people address this risk. The walk-away right is the easiest one for a buyer. Obviously, a seller and a lender would not want to have a full walk-away right for a buyer. There are more creative solutions that make their way into these deals. For example, will a buyer fund that into escrow? As long as the proposal is never enacted, the money gets transferred over to the seller. Are there other protections? Is there an insurance policy? There's a lot of work done to try to get the deal to work and not have a pure walk-away right. A large part of that is driven by the other parts of the capital stack, namely you want tax equity to fund, and you want the lenders to fund. We try to look for ways to avoid situations that have a complete walk-away right for a proposal that may never materialize.

JW: Sam, you touched briefly on insurance there. How, how might insurance be able to mitigate some of the change in law considerations?

SK: Yeah, it's a good question, and one that a lot of insurers are focused on. For an actual change in tax law, the insurers have developed a product where if a project is placed in service and everybody is comfortable that the requirements for the ITC have been satisfied or the PTC have been satisfied, and if the insurance policy is bound but later in the year Congress changes the law, the insurance policies don't shift that risk back to the taxpayer and say, “We're turning off your policy because something happened after fact.” When there's proposed changes in tax law, it's again, the policy won't turn off if there's a proposed change in tax law, because it kind of goes into the dynamic of if the proposal is out there and you place your project in service and it's funded, but then later on that proposal is enacted, the insurers will continue to respect the law as it was as of the time that the project was placed in service.

In terms of retroactive changes in tax law and how that's going to feed into the system, I think insurers are still focused on that as part of their underwriting process. It's one that has a lot of discussion and thought in current transactions.

‍JW: Do you expect any other changes in the TCTAs to address the regulatory environment? For example, do you expect payment terms to shift to the right, meaning buyers are not willing to pay for 2025 credits earlier in the year, pending the outcome related to tax reform?

SK: So I think that's going to be a very — it's an adjacent point to the proposed changes in tax law. It would be very hard for a buyer to convince a seller that they should enter into a TCTA, but the buyer does not pay or delays the payment when there isn't a proposed change in tax law out there that could impact the credit itself. I think this will become more negotiated as we see proposals come out. So, for example, if there is a proposal in Q1 2025 that on its face is going to invalidate a buyer's credit, that's kind of the easy scenario to see where the parties would want to negotiate for an escrow-type approach or another approach that allows the buyer to delay their funding until there's more certainty.

But in the absence of proposals or actual changes in tax law, it's unclear why a seller would agree to delayed fundings, particularly if they're dependent on their lender providing the construction debt for the project to move forward.

JW: Sam, in closing, what should we ask that we didn't already ask?

SK: I think a lot of this focuses on “what is a buyer's risk tolerance and what are they most focused on?” If somebody's looking to buy tax credits, if there's well-established technologies that are known to have a lot of support, do you need to have as many protections as for, say, the EV-type credits? What about energy communities? What about adders? Those are other ways that Congress can approach a pay-for if they want to take away from the credits to fund other priorities. People might want to focus on if the energy communities are repealed or if the domestic content adders are taken away. We still have a base credit available, it's just not as high of a quantum as before.

Those areas that can impact a lot of credits without taking away credits for a particular technology. Another area is pulling forward the sunset dates. Pulling forward the sunset dates is like repealing an energy community in that if a credit is going to expire in 2032, but they pull it forward to 2028. Again, the credit for the technology is there. It might not be there as long as people had anticipated. Those types of actions can open up areas in the budget for other priorities. So I think it's important to kind of think about the possibilities not just from a “it's going to disappear at the end of 2025” type of way, but what are the other ways that it can be modified and how do we plan our spend around those different types of modifications?