The Inflation Reduction Act of 2022 (IRA) enacted a wide range of legislation intended to further a variety of policy goals, including decarbonization, energy and resource security, environmental justice, and good-paying job creation. It did so by providing economic subsidies in the form of lucrative tax credits that could then be monetized through either direct consumption by project owners or the novel methods of “direct payment” or transferability.
The energy storage industry was one of the major beneficiaries of the IRA’s new rules on both the deployment and manufacturing sides. The IRA enacted the long-sought investment tax credit (ITC) under Section 48 of the Internal Revenue Code (Code) for standalone energy storage facilities. It also enacted a new “advanced manufacturing” production tax credit (PTC) under Section 45X of the Code applicable to the US-based production of a variety of clean tech equipment and critical minerals, including energy storage equipment and underlying materials and minerals.
Given its broad reach and introduction of many new concepts into the Code, the IRA explicitly and implicitly relies on a significant amount of IRS and US Treasury Department (Treasury) guidance for interpretation and implementation. The following briefly describes some of this guidance released during the almost year and a half since the IRA was enacted that is of significance to the energy storage industry. It should be noted that almost all of this guidance is subject to change, including in reaction to requested stakeholder input.
DEPLOYMENT
ITC – Proposed Regulations REG-132569-17 (Nov. 22, 2023)
The ITC guidance retains the Code’s broad approach to defining new ITC-eligible energy storage property but does include a nonexclusive list of qualifying technologies (but excludes hydrogen storage property for the production of end products other than energy, such as fertilizer).
The guidance confirms that a separate PTC-generating project may be co-located with a separate ITC-eligible project. Principally, this means that a PTC-electing eligible energy production facility (such as a solar facility now eligible to elect to use the PTC after the IRA) may be paired with an energy storage facility without impacting the ability to claim an ITC for the storage facility.
The guidance also allows for an ITC to be claimed on such a facility’s power conditioning and transfer equipment (e.g., a step-up transformer) that is properly allocated to the ITC facility (e.g., for which the ITC facility bears the cost) notwithstanding that it is also used by the PTC facility.
The guidance also confirms that the dual-use property limitations no longer apply to limit an ITC-claiming energy storage facility from charging from a source other than an ITC-eligible generation facility.
Prior to the IRA’s expansion of the ITC to apply to energy storage facilities, these dual-use property limitations effectively precluded a standalone energy storage facility from claiming the ITC and in practice also resulted in restrictions or prohibitions on grid-charging an energy storage facility integrated into an ITC-eligible solar or wind generation facility (with the ITC being claimed on the energy storage facility).
Prevailing Wage and Apprenticeship – IRS Notice 2022-61 (Nov. 30, 2022), Proposed Regulations REG-100908-23 (Aug. 30, 2023), REG-132569-17 (Nov. 22, 2023)
Subject to a “begun construction” grandfathering provision, an energy storage project with a one-megawatt-or-greater maximum net output must comply with US Department of Labor/Davis-Bacon Act premised prevailing wage and apprenticeship (PWA) requirements or be subject to an 80% reduction in the generally expected 30% ITC.
The PWA guidance establishes that the “begun construction” grandfathering to not be subject to PWA requirements applies to projects beginning construction before January 29, 2023. The longstanding “begun construction” analysis set forth in prior IRS guidance historically employed for navigating pre-IRA tax credit stepdown or sunset dates applies for purposes of this standard.
The PWA guidance also provides relatively rigid rules for how project owners comply with and document compliance with the PWA requirements. The documentation must include, at a minimum, payroll records for each laborer and mechanic (including each qualified apprentice) employed by the taxpayer, contractor, or subcontractor in the construction, alteration, or repair of a qualified facility. The guidance also provides a list of examples of documentation that “may” be included among records sufficient to demonstrate compliance.
The form of these best practices requirements and risk allocation over failure to comply with PWA requirements as set forth in applicable engineering, procurement, and construction (EPC), operations and maintenance (O&M), manufacturer, and other service provider documentation has initially been a contentious matter for negotiating between contracting parties, although more recently a generally viewed “market” approach on compliance and risk allocation has developed. But those providers without a historical practice of complying with Davis-Bacon Act rules are being forced to adopt compliance procedures in real time, often with the assistance of third-party consultants.
Further, the guidance provides rules pertaining to taxpayers’ ability to cure PWA noncompliance without resulting in an 80% reduction in the ITC. These include permissive exceptions to the payment of IRS penalties (but not backpay with interest to underpaid laborers or mechanics) for certain minimal noncompliance or if the pay is made pursuant to a prehire collective bargaining agreement with one or more labor organizations. This guidance also limits the period for cure of PWA requirement noncompliance to 180 days after receipt of notification of the noncompliance from the IRS.
Domestic Content – IRS Notice 2023-38 (May 12, 2023)
An energy storage project (among others) is eligible for an “adder” bonus credit (generally an additional 10% ITC) if it satisfies US Federal Transit Administration–based “Buy America Requirements” for domestic content.
The domestic content guidance provides relatively stringent rules for determining whether any steel, iron, or manufactured product incorporated into a clean energy facility was produced in the United States in order to be eligible for the adder.
Specific to energy storage, the guidance provides a “safe harbor” list breaking down an energy storage facility among its applicable project components constituting steel or iron (which must be 100% US-sourced) and manufactured products (which are subject to a more permissive standard based on percentage of applicable costs associated with US manufacturing). This safe harbor list further distinguishes between the manufactured product components of the battery pack manufactured product to include, among other items, battery cells, all of which also must be tested for US sourcing.
This guidance also effectively requires project owners to certify the location of manufacturing activity, as well as the associated cost, of manufactured equipment vendors and possibly their subcontractors to substantiate satisfaction of the manufactured products requirement.
The domestic content guidance has not been viewed favorably by the energy storage industry. For one, there remains ambiguity in the way the guidance’s rules operate with respect to every material incorporated into a facility or manufactured product. Also, as expected, the implicit requirement for vendors to provide their own cost information has proven challenging as most vendors understandably view this to be secret proprietary information.
These first two impediments have made it challenging in other technologies for manufacturers to certify their products as entirely US-sourced or for projects to be financed based on domestic content adder qualification. Further, there are concerns that the domestic content adder is generally not available for energy storage facilities until additional portions of the production supply chain are onshored because of the way this guidance breaks down an energy storage facility among its components (particularly with regard to battery cells).
Energy Community – IRS Notice 2023-29 (Apr. 4, 2023), IRS Notice 2023-45 (June 15, 2023), IRS Notice 2023-47 (June 15, 2023)
An energy storage project (among others) located in an “energy community” receives an “adder” additional credit (generally an additional 10% ITC).
The energy community guidance provides definitional rules for each of the three categories of energy communities (Brownfield Category, Coal Closure Category, and Statistical Area Category). Of note, the energy community guidance includes a list of applicable geographical areas for purposes of Coal Closure Category and Statistical Area Category locations, which are also reflected in US Department of Energy published maps.
The energy community guidance also provides a helpful rule that deems a project to be located in an energy community when it is placed in service (the ITC-based eligibility test) if it is located in an energy community on the day it “begins construction” (if after 2022). This is particularly important for projects expecting financing based on a Statistical Areal Category location, which qualification can change from year to year based on local and national unemployment rates.
Manufacturing
Advanced Manufacturing PTC – Proposed Regulations: REG–107423–23 (Dec. 15, 2023)
The Code Section 45X advanced manufacturing credit provides a PTC for the US-based production of, among other things, qualifying battery components (including electrode active materials, battery cells, and battery modules) and a variety of critical minerals (including lithium, cobalt, and nickel).
The advanced manufacturing PTC guidance provides general rules and principles for determining when activities rise to the level of eligible production, how qualifying production is to be documented and reported, how production of PTC-eligible components down the production chain is eligible for the PTC, and how related-party sales of eligible components operate.
Of particular note, the guidance does not treat critical mineral extraction costs as creditable (critical mineral production credit is based on 10% of production costs). As a result, it is not clear whether the advanced manufacturing PTC will directly incentivize domestic critical mineral extraction.
Monetization
Credit Transferability and Direct Payment – Proposed and Temporary Regulations: REG-101610-23, REG-101607-23, T.D. 9975 (June 14, 2023)
The IRA introduced a limited ability to receive a direct payment from the government through refundable clean tech tax credits as well as the novel ability to sell clean tech tax credits. Only tax-exempt and US federal, state, local, or tribal governmental entities (including Alaska Native Corporations), the Tennessee Valley Authority, and corporations operating on a cooperative basis engaged in furnishing electricity to persons in rural areas are generally eligible for direct payment of credits (generally eligible “applicable entities”).
However, as relevant to this discussion, taxpayers not included on this list are eligible for direct payment for a five-year period with respect to the Code Section 45X advanced manufacturing PTC. The IRA separately enacted the novel ability of taxable entity project owners (generally, those not eligible to claim refundable credits) to sell all or a portion of their tax credits with respect to a particular year for cash.
The IRS and Treasury provided extensive guidance on credit transferability and direct payment in June 2023. While a more fulsome discussion is beyond the scope of this article, the following provides certain important aspects of this guidance.
For purposes of credit transfers, the guidance clarifies that ITC recapture risk is borne by the credit buyer. That being said, the guidance expressly permits credit-transferring counterparties to cause the economic risk of recapture to be borne by the credit seller, such as through a contractual indemnity, which has been and is expected will continue to be the predominant market practice for credit sales where recapture is possible.
The guidance also provides for a helpful approach as to how the sale of credits operate for transferor and transferee partnerships in a way intended to allow partners flexibility in how a project’s credits (or a portion of such credits) are monetized as among each other. Finally, the guidance confirms that individuals (including through partnership ownership structures) are subject to longstanding limitations on their ability to monetize purchased tax credits (principally, the passive activity credit limitation rules) thereby effectively excluding them from the credit purchase market.
For purposes of credit direct payment, the guidance provides that partnerships and S corporations can never be “applicable entities” generally eligible to claim a credit direct payment.
As a result, an “applicable entity” (e.g., a tax-exempt organization) cannot form a partnership with another entity (including another applicable entity) to pursue an activity producing a clean tech credit and claim a credit direct payment other than for the limited permission for all taxpayers to claim a direct credit payment for the Code Section 45X advanced manufacturing PTC and two other credits (Section 45Q carbon capture and sequestration credit and Section 45V clean hydrogen PTC) for a five-year period.
This was a surprising result to the market that had anticipated being able to accommodate direct pay in public-private partnerships. Unless this restriction is addressed in further guidance, it will most likely discourage tax-exempts and other “applicable entities” from pooling resources to participate in a clean tech project.
The transferability guidance and the direct payment guidance provide similar, significant documentation and substantiation requirements. Of note, each requires a subject facility to make an online registration with the IRS to claim a transfer or direct payment of credits. The IRS online portal finally opened to the general public in late December 2023. Notwithstanding this timing, credit buying and selling parties in the market began actually transacting in earnest after the release of the transferability proposed and temporary regulations in June 2023.
Other Insights in this Report
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