Transfer Away! Treasury Releases Preliminary Ground Rules for Tax Credit Transfers

As background, the Inflation Reduction Act of 2022 (the “IRA”) provided that, for taxable years beginning after December 31, 2022, eligible taxpayers may elect to transfer certain credits to an unrelated taxpayer pursuant to new Code section 6418. The transfer election in Code section 6418 is available for the investment tax credit (“ITC”) (Code section 48), the production tax credit (“PTC”) (Code section 45), the carbon oxide sequestration credit (Code section 45Q), the technology neutral ITC (Code section 48E) and PTC (Code section 45Y), the alternative fuel vehicle refueling property credit (Code section 30C), the zero-emission nuclear power production credit (Code section 45U), the clean hydrogen production credit (Code section 45V), the advanced manufacturing production credit (Code section 45X), the clean fuel production credit (Code section 45Z), and the qualifying advanced energy projects credit (Code section 48C). Generally, any taxpayer that is not an “applicable entity” for purposes of the direct pay election under Code section 6417 is treated as an “eligible taxpayer” that may elect to transfer all or a portion of its credits pursuant to Code section 6418 to an unrelated buyer.²

The proposed regulations (REG-101610-23) are fairly comprehensive (over 100 pages in length) and provide detailed guidance on a host of topics, issues, and nuances raised in connection with Code section 6418. A fulsome summary of these regulations is beyond the scope of this alert, but notable items include:

• Essentially all U.S. taxpayers are eligible taxpayers, including taxpayers that have a United States employment tax or excise tax obligation even if they do not have a United States income tax obligation.
  • To the extent applicable, tax-exempt use rules still apply to transferor taxpayers and may reduce credits otherwise available for transfer.³ However, partnerships with tax exempt partners, non-U.S. partners or a mix of tax exempt, non-U.S. or taxable partners should still be eligible taxpayers (i.e., eligible to transfer credits under Code section 6418).⁴
  • Taxpayers that were passed an ITC through an inverted lease transaction or a 45Q credit through a Code section 45Q(f)(3)(B) election may not transfer those credits. However, the purchaser/lessor in a sale-leaseback transaction that owns the eligible credit property when it is placed in service can elect to transfer eligible credits.
• It appears separate registration and transfer elections must be made for each item of credit generating property (for example, for each wind turbine generating PTCs). However, for ITC energy property, an eligible taxpayer may have the option to make a single transfer election for an energy project.
• All or a portion of an eligible credit may be transferred to one or multiple buyers. Eligible credits that may be transferred include any “bonus credits” available through applicable adders, but such “bonus credits” cannot be transferred separately from the underlying base credit.⁵
• Transfers of credits must be for “cash” which is defined as payments made in U.S. dollars by cash, check, cashier’s check, money order, wire transfer, automated clearing house (ACH) transfer, or other bank transfer of immediately available funds. While contractual commitments to purchase credits in advance of their generation are permitted, the cash payment cannot be made earlier than the first day of the eligible taxpayer’s taxable year in which the credit is generated and generally no later than the due date for the tax return (including extensions) that includes the transfer election statement.⁶
  • Income received in connection with a sale of credits is not subject to tax; the proposed regulations include a broad anti-abuse rule that could result in recharacterization of a transaction’s income tax consequences in order to prevent abuse of this tax-exempt treatment.
  • Transferees are not subject to tax for any discount on a purchased credit.
• While buyers of credits generally bear recapture risk and liability for excessive credit transfers, buyers and sellers of credits are permitted to contract for indemnification rights and obligations.
  • Buyers of credits are not subject to recapture risk if a partner sells its interest in a transferor taxpayer that would otherwise cause recapture, but the partner is responsible economically as if the sold credit were recaptured.
  • The proposed regulations describe the reasonable cause exception to the 20% penalty that generally applies to excessive credit transfers. In order to avoid this 20% penalty on an excessive credit transfer, buyers should conduct diligence to confirm the availability and amount of eligible credit, obtain relevant third party reports, negotiate a fulsome set of representations, and review seller’s financial statements.
• With respect to transferor taxpayers that are partnerships:
  • The partnership may elect to transfer a portion of credit that would otherwise be allocated to a specific partner, and any tax-exempt income from that sale may be allocated to that same partner.
    • For example, in a 99/1 tax equity partnership, the partnership may sell the 1% eligible credit that would otherwise be allocated to the sponsor, and the tax equity investor will still receive its 99% share of the eligible tax credit. The sponsor would be allocated all of the tax-exempt income from the sale of such tax credit.
  • The preamble to the proposed regulations clarifies that cash received in connection with the transfer may be distributed or utilized however the partners so choose.
• With respect to transferee taxpayers that are partnerships:
  • The purchased credit is treated as an “extraordinary item” and is allocated among the partners in the manner they would otherwise share non-deductible expenditures.
  • An allocation of a purchased credit to a direct or indirect owner of a partnership does not violate the rule against second transfers under Code section 6418.
• The preamble to the proposed regulations confirms that a transferee taxpayer may take into account the specified credit portion it has purchased, or intends to purchase, when calculating its estimated tax payments.
• Transferors must pre-register the underlying eligible credit property before filing the return reflecting a transfer, and any transfer of credit that was not pre-registered or does not reference the registration number on the applicable tax return is essentially invalid.
• There is a laundry list of items that may be required to be included in a tax return in connection with a transfer election, including a “transfer election statement” that must be signed under penalty of perjury by the transferor and transferee taxpayers. For transfers of credits that span multiple years, the election must be made for each year of the transfer.
• Syndicators or brokers for credit transfers are permitted, but because a credit may only be transferred once, they must not act as an intermediary buyer of the credits.
  • Individual and closely held buyers of tax credits are subject to passive loss limitations under Code section 469.
• Buyers can carry purchased credits back three years and forward 20 years. However, credits that have been carried-forward or backwards cannot be transferred.

Treasury also released temporary regulations setting forth mandatory information and registration requirements for taxpayers planning to make a Code section 6418 election.

¹ Prior to issuing final regulations, Treasury and the Service will accept comments on the proposed regulations prior to August 14, 2023, and plan to hold a public hearing on August 23, 2023.

² Our prior coverage of the transfer election introduced in IRA can be found here (See “5. Credit Flexibility”) and here.

³ Transferors are also subject to the at-risk limitation rules in Code section 49.

⁴ We anticipate that this will be an issue that taxpayers comment on and, hopefully, final regulations will permit grouping of facilities/property.

⁵ Note that the type of bonus credit depends on the eligible credit, but generally arise from satisfying prevailing wage and apprenticeship requirements, locating a qualifying project in an energy community or low-income community, or satisfying manufacturing domestic content requirements.

⁶ Transfers may not be made pursuant to amended returns or administrative relief for late filing.