The benefit of their bargain: expert insight from Kirkland & Ellis’ Sam Kamyans on the market for transferable tax credits

The market for clean energy tax credits is growing rapidly, made up increasingly of new participants, both corporate taxpayers who are buying credits and project developers who are selling them.

Crux had the opportunity to interview Kirkland & Ellis Partner Sam Kamyans, who is a leader in structuring tax credit transactions and tax equity partnerships. Sam shared his thoughts on how new entrants on both sides of the market should be looking at these opportunities as they begin to familiarize themselves with tax credit transfers and pursue their first transactions.

Interview transcript

Starting with some basic information about the tax credit market: what, in your experience, is bringing new tax credit buyers into the market at this point?

We get inbounds from a number of companies that are making their way to the market, and a lot of the considerations, particularly for large taxable organizations, are twofold. One, understanding ways that they can reduce their overall tax liabilities — transferability is one option that provides an opportunity for companies to achieve the tax reduction objective.

Second, they view it as a meaningful way to finance and get involved in the energy transition. That encompasses investing in solar projects, wind projects, carbon capture, anything that reduces the carbon intensity of various energy outputs. One thing that has been appealing to a number of these buyers is this notion that it's a much simpler transaction versus traditional tax equity deals — we can talk about that shortly.

When you combine the simplicity of these transactions with the ability to access the burgeoning energy infrastructure market and reduce tax liability, these are areas that are appealing enough to buyers where they want to understand more. They want to know how they can achieve all these goals, ensuring that it's not too good to be true.

Knowing that you've engaged with folks on both sides of one of these transactions, it seems that parties on the buying side of the transaction very commonly approach the market with that “is this too good to be true” question framework. Thinking about that, we need to acknowledge that there are both benefits and risks within these transactions. What would you describe as some of the more significant risks or obstacles that a buyer needs to address when they're preparing to pursue a transaction?

I think there's two main obstacles. The first one is the internal approvals that are needed to explore the transaction, which we typically don't discuss directly with a buyer. For instance, think about a Fortune 500 company who first has to go through the layers of approval internally to convince their treasury department that this is a viable path to reduce their effective tax rates. They have the internal education that needs to be done before they engage with the market. But once they're comfortable internally, the obstacles that we see as they approach the market are really in terms of the learning curve.

First, understanding both how a transaction operates and understanding who they should be speaking to in order to get access to the sellers of these credits. Having the idea to purchase credits and reduce your effective tax rate is both novel and appealing. Then identifying who the counterparty is going to be is a pretty major gating item to move forward.

As buyers get comfortable with this type of transaction, marketplaces such as Crux are educating buyers in terms of what the universe looks like. Their next considerations become   what are the risks that this transaction entails, and how do we manage around those risks?

Segueing into that next line of thinking, the internal process then shifts to what are the risks associated with the projects, both in terms of its operations and creation of the tax credits so that we receive the benefit of our bargain.

I think what buyers are finding more and more is that the risk of the tax credit materializing is probably the easiest risk that they can control for. Buyers aren't paying for tax credits until they've verified that they do exist. This is a function of ensuring that the project is on schedule, that it's being constructed, that the counterparties and the expert reports that are involved in putting the project online are trustworthy and are able to execute on the schedule and bring it online.

At the top you mentioned the simplicity of this transaction relative to a tax equity transaction. I would assume that we do have many entrants in the market who are familiar with tax equity, but maybe not historical participants in the tax equity market. Comparing or contrasting the process that you just described, how does that vary from the process that a tax equity investor might use?

The best way to think about it is that both tax equity and a tax credit purchaser will likely go through the same process of ensuring the viability of the project and its existence. For a tax credit buyer in the transfer market, their main due diligence ends there. There are going to be some other key areas to look at in terms of the financial responsibility of the sponsor who's selling it, ensuring that they have the creditworthiness to make good on any issues with the tax credit down the line.

Whereas in a traditional tax equity transaction, tax equity is contributing money into the operating company that's going to hold the project. They have all the operations and maintenance contracts that are responsible for moving the project along, earning money, distributing some of the cash from the operations to tax equity. And the investor looks to their return as a mixture of tax credits, tax benefits, and operating cash flows. There's a lot more involvement in terms of ensuring that the project is going to work well and that there's enough operational cash flows to fund their return.

Then there's the other side of the equation in the event there aren't enough operational cash flows to fund their returns. What rights can they negotiate to, to step in and demand more cash from the project company? What governance rights do they have? How do they interact with a lender? So in a tax equity deal there is this focus on ensuring that the project is viable and can kick off the tax credits, but there's also so much more in terms of ensuring that, for the duration that they are a partner in this partnership, the economics and the governance work in a manner that enables them to get their return.

The tax credit buyer has none of this headache. Once the project is verified online and can give rise to the tax credit, they can purchase that tax credit. The real risk on the investment tax credits (ITC) is ensuring that the project does remain in service and operational for five years to avoid a recapture and get the full benefit of their bargain.

Considerably simpler relative to tax equity, but there still is quite a bit of wood to chop to ensure that the deal works.

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When we think about the categories of buyers who might approach this market, for instance a large publicly traded company or a multinational company, are there unique risks that you would advise that category of buyer to be thinking about that are distinct from maybe a smaller or privately held entity?

Yeah, absolutely. I'll start with the multinationals. This'll be familiar to any multinational, but these companies agree to minimum taxes across a number of Organization for Economic Co-operation and Development (OECD) jurisdictions to discourage companies from shifting income into a low tax jurisdiction. Ultimately what they've agreed on is something called Pillar Two, which they are in the process of implementing. This is a minimum tax on multinationals that operate in low tax and high tax jurisdictions and cuts right into the use of tax credits in a high tax jurisdiction.

Tax credits can end up causing a certain jurisdiction's tax rate to go below the minimum tax and require what's called a top up tax to get that multinational in compliance with each one of the jurisdictions. One thing that we've seen come up quite a bit in these deals is the buyers ensuring that they size the amount of tax credits they purchase in a way that doesn't cause them to go below their minimum tax thresholds.

From a seller's perspective, they fully view this as a buyer's risk and they're unwilling to reduce the value of the price of the credit to accommodate the buyer's Pillar Two considerations. But that is a major financial modeling point that a multinational buyer will think about. A lot of them have learned to manage it internally, and so they're comfortable with computing the value of the credits relative to Pillar Two.

Once you leave the multinationals, this issue entirely goes away. So it gets simpler as the company has less of a global presence. Then the question becomes are there special SEC reporting rules? Or how is the tax credit purchase going to hit my financial statements that the effective tax rate has been lowered and how have I done it?

I think those considerations are still being developed. The punchline will be that for those smaller, non-multinational companies, they'll have a lower effective tax rate and how they have to comply both from SEC, GAAP, et cetera, is still kind of being hashed out.

As you go outside of the public capital markets for corporations that don't have these reporting obligations, they just have less compliance to take into account.

When you think about the reporting requirements for the IRS, and particularly given the finalized transferability guidance that we received last week, are there any special tax requirements or treatments that companies need to be aware of as they're pursuing these transactions and accounting for them on their tax filings?

The major one that comes up is when you have a mismatch between the tax return filing date for the buyer and the seller. Without getting into a whole lot of detail, if both the buyer and the seller are calendar year taxpayers, the accounting and the timing of when the buyer uses that credit is consistent with when the seller sells it. If the seller is calendar year and the buyer isn’t, this has both compliance and timing impact for the buyer. The punchline is that they're going to use the credit later than they thought they were eligible to.

Mismatched buyers and sellers are subject to a different set of compliance and timing rules. But beyond those calendar year mismatches I think most everybody is in the same boat in terms of compliance and getting to a point where they can comfortably take the credits.

The other area that's worth spending a little bit of time on is that different asset classes have different compliance burdens. In order to transfer a credit, the IRS has put these registration requirements out there that the taxpayer has to list their project on the IRS's portal and identify each project separately. So if there's one large utility project, it'll have a single registration number that transfers all the tax credits with respect to one asset. Conversely, if there's a portfolio of a thousand residential systems that has a much higher compliance burden because the residential systems each get their own registration number because they're viewed as separate pieces of property. But beyond those things, the rules are fairly symmetric across all taxpayers.

In our experience we often, but not always, find that those additional compliance burdens or requirements are recognized in a price differential. Has that been your experience?

You can get that in one of two ways. There are instances where you might have an express discount due to the volume of individual pieces of property the buyer might have to look at. In a lot of deals, a buyer will require the seller to pick up part or all of its legal costs. If there's a significant amount of diligence due to having more than one asset that increases the overall transaction cost, then on a net basis the buyer can end up receiving less.

These are fairly fact driven by what the parties have agreed on commercially, both in terms of the headline price for the credit and the manner in which the parties share the transaction costs.

Are there special considerations that buyers are bringing into forward commitments or commitments to purchase a strip of production tax credits? Are you working on transactions that have a multi-year component and what are the considerations that you think are important for a buyer who might be looking at that?

We certainly see multi-year commitments on production tax credits. First and foremost, if the buyer is going to self-utilize, it's really incumbent on them to be comfortable that they can use the 10-year strip, five-year strip, whatever it may be. I think one feature of the multi-year production tax credit commitments is that the buyer wants an assignment right. This allows them to go ahead and sell the credits that they might not be able to use in the future. I think one of the paramount considerations on these long-term transferability deals is the assignment rights, and those are typically heavily negotiated.

We certainly do see those PTC strips transact and it's a rapidly evolving space in terms of buyers understanding the universe of possibilities for what they can do with those credits down the line, as well as having some flexibility in managing their internal tax capacity.

Do you have conversations with your clients at this point about the impacts that this transaction might have from a sustainability perspective? Does that come up? Are there impacts to working capital that buyers are identifying as a motivating factor to do a deal? What are the big motivating factors outside of tax management when companies are approaching this market?

I think there are certainly a lot of companies out there that view this as part of their overall environmental, social, and governance (ESG) portfolios, and they view this as a way to inject needed capital into accelerating those goals towards achieving net zero. Part of their calculus will also be their access to the renewable energy certificates (RECs) and other attributes that they can use internally to achieve their net zero goals. We certainly see those conversations happening.

Some companies require compliance with their labor practice laws so that, in addition to funding the energy transition, they are focused on avoiding bad labor practices. So there's certainly some areas in addition to tax rate management that come into the discussion, but I see those as ancillary to the tax credit itself and kind of a bonus if the buyer can achieve more than one objective.

Sam, from your perspective, what is the importance of a platform like Crux for companies that are purchasing tax credits for the first time?

I think just first and foremost, what Crux is doing for the marketplace is providing a level of visibility that simply didn't exist in tax equity before transferability. The notion that buyers and sellers can understand what is out there and how many different types of projects there are, how many different buyers and sellers there are, is just extremely important for getting the word out there that hey, there are a lot of projects that can be financed with tax credits.

From a seller's perspective, they want to know that they're getting the best price for their credit. If you only talk to one party, then you just have no idea what the market looks like. Whereas, if it's listed and there's competitive tension between buyers, then there's opportunity for price discovery. And if that provides more liquidity in the market, it leads to more projects being built and really accelerating energy transition in a more meaningful way than I think people expected when the transferability rules were proposed.

So just in terms of getting projects out there, creating visibility, Crux is really accelerating the market in a transformational way.

We've been very excited to see how much has happened in just the last 10 months since this market took off. As a closing question, very much in the vein of what you were just saying, what are your predictions for how this market might evolve in 2024?

Six months ago, I didn't think every single deal would have a transferability element in it. And now it's clear that every deal has at least the option to transfer the credits. From that optic and seeing the number of new entrants come in, the market's just going to expand more and more in 2024 as people become comfortable with buying credits. I see it on a very healthy upward trajectory. When that plateaus is to be seen. But it's going to expand for the foreseeable future.