How Does Renewable Energy Fare under House, Senate Tax Reform Proposals?
The Senate Finance Committee advanced the Tax Cuts and Jobs Act Nov.16, moving the tax reform legislation to the full Senate for consideration. The 14-12 committee vote was along party lines and came the same day as the House of Representatives passed its version of the legislation. The House passed its version of the Tax Cuts and Jobs Act (H.R. 1) by a 227-205 vote. The full Senate is expected to take up the bill after the Thanksgiving break.
In general, the Senate bill left out most of the changes that caused angst to the renewable energy industry. The Senate bill differs with the House bill by retaining the status quo with respect to the Section 48 investment tax credit (ITC) and the Section 45 production tax credit (PTC); namely the current ITC and PTC phasedown schedules remain in place. This is welcome news for the renewable energy community.
The wind industry was initially caught off guard by the House legislation that proposed both a significant reduction in the PTC as well as new “continuous construction” requirements. Overnight the wind industry was dealt a legislative blow that has caused a number of transactions to be put on hold. As written in the House bill, the repeal of the inflation adjustment for electricity produced at a facility for which construction begins after the date of enactment will have a significant adverse impact on the wind industry. This is because a wind facility that commences construction after the date of enactment will only qualify for a PTC rate of 1.5 cents per kWh over the 10-year credit period (a 37.5 percent reduction compared to PTC rate of 2.4 cents per kWh under current law). To add insult to injury, the “continuous construction” has created confusion for developers trying to understand if the new rule is intended to codify previous IRS guidance or whether it represents a new standard. If it’s a new standard, developers are concerned that equipment purchased in 2016 as part of a safe harbor strategy may now be for naught. They may not meet the new continuous construction standard and their project may no longer be financially feasible at 1.5 cents per kWh. This appears to be a fluid issue with differing views on whether a new “continuous construction” requirement was intended. Novogradac is monitoring this issue and will provide additional clarification as it becomes available.
The Senate bill did not include the changes the House made to the PTC. Instead the Senate left in place the PTC phase out schedule agreed to in the December 2015 extension.
The solar industry appears to have escaped relatively unscathed from the direct impacts of the proposed Senate and House bills. The House bill has the 10 percent ITC for solar expiring at the end of 2027 as well as similar continuous construction requirements similar to the wind PTC. The Senate bill, like the House bill, left in place the ITC phase out schedule agreed to in the December 2015 extension. So, unlike the wind industry, the solar industry has more time to plan and prepare for the ITC phase out and the logistics and planning required to meet the continuous construction requirements.
The House bill as it is currently drafted includes some good news for the industry in that it extended the ITC for the “orphaned” renewable energy technologies that were left out of the December 2015 ITC extension. The orphaned technologies include fuel cells, small wind, CHP, geothermal and microturbines. This small victory, however, was quelled by the Senate bill which left these technologies out and thus continued to leave the orphaned technologies in limbo. The Senate’s plan is now to potentially include the orphaned credits in a tax extenders bill that will likely be combined with legislation to extend the continuing resolution to fund the government past Dec. 8.
Corporate Tax Rates
Both the House and Senate bills would lower the corporate tax rate from 35 percent to 20 percent. In an effort to reduce the cost of this provision, however, the Senate bill delays the rate reduction until after 2018, effectively one year later than the House bill.
Regarding bonus depreciation, the Senate bill generally follows the House with one important exception; the Senate bill does not allow bonus depreciation on used property. In both bills bonus depreciation is increased from 50 percent to 100 percent effective for property acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2023 (subject to an exception for regulated public utilities).
Interest Expense Limitation Provisions
Consistent with the House bill, the Senate bill disallows a deduction for net interest expense in excess of 30 percent of a business’s adjusted taxable income (subject to an exception for regulated public utilities). There are a couple of minor differences between the bills but both are generally similar.
Base Erosion Tax
The Senate Finance Committee’s tax reform bill includes a “base erosion minimum tax.” In general, the proposal would impose a 10 percent minimum tax on multinational companies if they make deductible payments to foreign affiliates that exceed a certain threshold. This would apply to any deductible amounts paid or accrued to foreign affiliates including amounts paid or accrued to such foreign affiliates for depreciable property. This tax would generally apply to corporations (exception for RICs, REITs and S corps) with average annual gross receipts of at least $500 million for three years preceding and with a “base erosion percentage” of 4 percent or more for the year.
The Senate bill would not allow tax credits to offset the base erosion minimum tax except for the Section 41 research and development (R & D) credit. ITC, PTC, low-income housing tax credits (LIHTCs), new markets tax credits (NMTCs) and historic tax credits (HTCs) could not be used against this tax. Tax credits unused due to not being able to offset this tax do not appear eligible to be carried forward. It should be noted the base erosion minimum tax is calculated similar to the alternative minimum tax, which the Senate and House bills repeal. In essence, if a corporation’s minimum tax exceeds their regular tax, after the regular tax is reduced by all tax credits other than the R& D credit, that excess is an additional tax. An addition to the corporation’s regular tax.
Sen. Maria Cantwell, D-Wash., offered an amendment to address the base erosion minimum tax, but the Senate Finance Committee did not approve it in its bill. However, during the consideration of Cantwell’s amendment, Sens. Rob Portman, R-Ohio, and Charles Grassley, R-Iowa, both expressed interest in addressing the issue, and reports suggest Chairman Hatch is currently considering ways to address it.
Practitioners in the renewable energy field and other affected industries fear the base erosion “add on” tax could discourage or dissuade multinational companies with U.S. tax appetite from making tax credit investments. This is primarily because large banks and other large multi-national corporations that make significant payments to their foreign affiliates for regulatory and/or other reasons may find it a difficult task to project whether they will be subject to the base erosion minimum tax and whether or not their tax credit investments will be able to monetized in a given year due to the mechanics of the rules. Practitioners are hopeful the potential harm to ITC, PTC, LIHTC, NMTC and HTC communities was not the Senate Finance Committee’s intent.
As the Senate bill moves on to full Senate consideration after Thanksgiving, many believe the inclusion of the repeal of the individual mandate under the Affordable Care Act could complicate the bill’s passage. With the state and local tax deduction also a contentious item, it is uncertain whether the Senate tax reform bill can pass without any significant changes, not to mention a final bill through both chambers. That said, the renewable energy community should not underestimate the desire of the Republican Party to get some form of tax reform legislation passed. Stay tuned.