Proposed Regulations for Transfer of Energy Credits under IRA

There is a 60-day public comment period (through August 14, 2023) following in which the Treasury and IRS will consider public feedback and issue final rulemaking with respect to these provisions and the pre-filing information and registration process.

Overview
Section 6418 of the Code was added by the Inflation Reduction Act on August 16, 2022, to allow an “eligible taxpayer” (Transferor) to transfer all or any portion of “eligible credits” from an “eligible credit property” to an unrelated taxpayer (Transferee) by making a “transfer election.”

Who Are Eligible Taxpayers?
An “eligible taxpayer” is generally any person subject to any internal revenue tax. Technically, an “eligible taxpayer” is defined in the negative as any taxpayer that is not described in section 6417(d)(1)(A) (i.e., an entity or taxpayer that is not any of the following: an organization exempt from income taxes, any state or political subdivision thereof, the Tennessee Valley Authority, an Indian tribal government, an Alaska Native Corporation, or any corporation operating as a cooperative that is engaged in furnishing electric energy to persons in rural areas). (Note that the entities described in section 6417(d)(1)(A) are eligible to make direct pay elections for certain eligible credits pursuant to section 6417 and on June 14, 2023, the Treasury and the IRS released a Notice of Proposed Rulemaking setting forth Proposed Regulations §§ 1.6417-1 through 1.6417-6 which provides proposed guidance on section 6417.)

For purposes of section 6418:

• If an eligible taxpayer is the sole owner (directly or indirectly) of a disregarded entity for federal income tax purposes which holds the eligible credit property, then the eligible taxpayer may make the transfer election.
• A partnership or S corporation which holds the eligible credit property may qualify as a Transferor and make a transfer election. No partner or shareholder may make a transfer election with respect to any eligible credit property owned by a partnership or S corporation.
• In the case of a consolidated group of corporations, each member of the consolidated group will be treated as a separate eligible taxpayer.
• In the case of undivided ownership interests, such as a tenancy-in-common, each tenant in common will qualify as an eligible taxpayer with respect to its undivided ownership share of the eligible credit property.
• A lessee of property who has been transferred tax credits pursuant to section 50(d)(5) and an election under Treasury Regulation § 1.48-4 does not qualify as an eligible taxpayer for purposes of any further transfer of such tax credits.
• In the case of a sale/leaseback transaction, the purchaser/lessor can qualify as an eligible taxpayer with respect to the eligible credit property owned and treated as originally placed in service by the purchaser/lessor.

What Are the Eligible Credits?
“Eligible credits” are defined to include the following clean energy credits:

• Credit for alternative fuel vehicle refueling property (section 30C credit);
• Renewable electricity production credit attributable to qualified facilities (section 45 credit);
• Credit for carbon oxide sequestration attributable to carbon capture equipment (section 45Q credit);
• Zero-emission nuclear power production credit (section 45U credit);
• Credit for production of clean hydrogen attributable to qualified clean hydrogen production facilities (section 45V credit);
• Credit for advanced manufacturing production (section 45X credit);
• Clean electricity production credit (section 45Y credit);
• Clean fuel production credit (section 45Z credit);
• Energy credit (section 48 credit);
• Qualifying advanced energy project credit (section 48C credit); and
• Clean electricity investment credit (section 48E credit) (which replaces section 48 starting in 2025).

An eligible credit does not include any business credit carryforward or business credit carryback determined under section 39 of the Code. The entire amount of any eligible credit is separately determined with respect to each single eligible credit property of the Transferor and includes any bonus credit amounts determined with respect to that single eligible credit property, which means that bonus credit amounts cannot be separately transferred.

No election is allowed for credits that are not determined with respect to the Transferor, specifically, a section 45Q credit (carbon oxide sequestration) passed through pursuant to section 45Q(f)(3)(B) to a person that disposes of qualified carbon oxide, utilizes qualified carbon oxide, or uses qualified carbon oxide as a tertiary injectant.

What Is an Eligible Credit Property?
An “eligible credit property” is defined as the unit of property with respect to which the amount of an eligible credit is determined.

Pursuant to the Proposed Regulations, the appropriate unit of property differs based on the applicable eligible credit. The appropriate unit of property will be determined on (i) a property-by-property basis for eligible credits pursuant to section 30C, section 48 credit and section 48C, (ii) a facility-by-facility basis for eligible credits pursuant to section 45, section 45U, section 45V, section 45Y, section 45Z, and section 48E, and (iii) a single process train of carbon recapture equipment pursuant to section 45Q.

What Is a Transfer Election?
A Transferor must make a “transfer election” to transfer to a Transferee a specified portion of eligible credit determined with respect to an eligible credit property owned by the Transferor. A transfer election is irrevocable.

A separate election must be made with respect to each eligible credit property. The transfer election must be made with respect to a proportionate amount of the entire eligible credit with respect to the eligible credit property, i.e., including any applicable bonus credit amounts, but may be limited to only a percentage of the entire amount of such eligible credit. The Transferor can make multiple transfer elections to transfer one or more specified credit portions to multiple Transferees as long as (a) the aggregate amount transferred does not exceed the total amount of the available credit to be transferred and (b) a proportional amount of any component part of such eligible credit is transferred.

To make a valid transfer election, the Transferor must make an election for each transfer on its original tax return for the taxable year for which the credit is determined by the due date of such return (including extensions of time) but such an election cannot be made earlier than February 13, 2023). The transfer election must include (i) a properly completed relevant source credit for the eligible credit, (ii) a properly completed Form 3800, General Business Credit, (iii) a schedule attached to the Form 3800 showing the amount of eligible credit transferred for each eligible credit property, (iv) a transfer election statement (described below), and (v) any other information related to the election specified in guidance.

Although there is no required form of the transfer election statement, the Proposed Regulations set forth detailed rules regarding the content of the transfer election statement and require the Transferor and Transferee to each attach a copy of the transfer election statement to its respective tax return, labeled “Transfer Election Statement.” The Transfer Election Statement must be signed under penalties of perjury by an individual with authority to legally bind the Transferor and must be signed by an individual with the authority to legally bind the Transferee giving its consent to the transfer.

At a minimum, the Statement must include the following information: (i) the name, address and taxpayer identification number of both the Transferor and the Transferee, (ii) a statement that provides the necessary information and amounts to allow the Transferee to take into account the specified credit portion with respect to the eligible property, including the description of the eligible credit, the total amount of the credit and the amount of the specified portion of the credit, (iii) the taxable year of the Transferor and the first taxable year in which the specified credit portion will be taken into account by the Transferee, (iv) the amount of cash consideration and the dates paid by the Transferee, and (v) the registration number related to the eligible credit property. In addition the statement must include (a) an attestation that the Transferor is not related to the Transferee within the meaning of section 267(b) or 797(b)(1), (b) a representation by the Transferor that it will comply with all requirements under section 6418 and the Treasury Regulations, (c) a statement from the Transferor and the Transferee acknowledging the notification of recapture requirements, and (d) a statement from the Transferor that it has provided the Transferee the “required minimum documentation.”

For purposes of the foregoing, the required minimum documentation that the Transferor must provide to the Transferee consists of (A) information that validates the existence of the eligible credit property, (B) if applicable, documentation substantiating that the Transferor has satisfied the requirements to include any bonus credit amounts in the eligible credit, (C) evidence of the Transfer’s qualifying costs in the case of a transfer of any eligible credit that is part of the investment credit or the amount of qualifying production activities and sales amounts, as relevant in the case of a transfer of an eligible credit that is a production credit. The Transferee must retain the required minimum documentation provided by the Transferor as long as it may become material in the administration of any internal revenue law.

A Transferor of any section 48 credit, section 48C credit or section 48E credit must reduce the tax basis of the eligible credit property as if the transferred eligible credit was allowed to the Transferor.

Following such transfer, the Transferee will be treated as the taxpayer under the Code with respect to such transferred eligible credit. The Transferee may not make any further transfers of the transferred credit.

The transferred credit is taken by the Transferee into account in its first taxable year ending with, or after, the Transferor’s taxable year with respect to which the transferred credit was determined.

The Proposed Regulations include anti-abuse provisions that disallow a transfer election and credit transfer if the parties engaged in the transaction with the principal purpose of avoiding tax liability beyond the intent of section 6418. This would include transactions intended to decrease the Transferor’s gross income or increase the Transferee’s deductions.

Payments for Transfer
Payment for the transfer of eligible credits must be made in cash. The Proposed Regulations provision that a payment will be considered to be made “in cash” if it is made in U.S. dollars by cash, check, cashier’s check, money order, wire transfer, automated clearing house transfer, or other bank transfer of immediately available funds. Payments must be made in full during the period (a) beginning on the first day of the Transferor’s taxable year during which a specified credit portion is determined, and (b) ending on the due date for completing a transfer election statement, which must be completed by the Transferor and Transferee prior to the Transferor and the Transferee each filing its federal tax return for the taxable year in which the credit is determined.

A contract between the Transferor and the Transferee to purchase credits with U.S. dollars in advance of the date such credits are transferred satisfies the “paid in cash” requirement as long as all cash payments are made during the timing described above.

Passthrough Transferees, Partnerships and S corporations
The Proposed Regulations set forth a number of special rules regarding the application of section 6418 to eligible credit transfers by partnerships, S corporations and other passthrough transferees.

In the case of a Transferor partnership or S corporation:

• Any tax exempt income received by the Transferor partnership or S corporation in connection with any credit transfer will be treated as arising from an investment activity and not from conduct of a trade or a business (meaning it is not treated as passive income to any partners or shareholders who do not materially participate within the meaning of section 469(c)(1)(B)).
• A partner’s distributive share of tax-exempt income resulting from an eligible credit transfer will be based on such partner’s proportionate distributive share of the eligible credit that would have otherwise been allocated to the partners if not transferred.
• If it transfers less than all eligible credits determined with respect to the eligible credit property, the Transferor partnership may allocate to each partner its agreed upon share of remaining eligible tax credits, tax exempt income in connection with such transfer, or both, so long as there is no double-counting (i.e., eligible credits allocated to a partner do not exceed such partner’s distributive share of eligible credits and the amount of tax exempt income allocated to a partner equals its proportionate share thereof).
• If it receives cash payments in connection with transfer of eligible credits, the Transferor partnership is under no restriction on how it can use such cash payments (including making distributions to its partners).

In the case of a Transferee partnership or S corporation:

• The allocation of transferred credit to a Transferee’s direct or indirect owners does not violate the no second transfer rule.
• Any cash payments for a transferred eligible credit are treated as section 705(a)(2)(B) nondeductible expenditures. The eligible credit is then allocated based on applicable partner’s distributive share of section 705(a)(2)(B) nondeductible expenditures used to fund the purchase of the transferred credit (as set forth in the partnership agreement, if the partnership agreement is silent as to the allocation of such nondeductible expenditures or there is no partnership agreement, based on the Transferee partnership’s general allocation of nondeductible expenditures).

The Proposed Regulations also include additional special rules applicable to any Transferor and Transferee S corporations and their shareholders and for REITs.

The Treasury Department and the IRS are developing rules and seeking comments on (a) the federal income tax treatment of transaction costs, either for the Transferor or the Transferee and (b) whether a Transferee is permitted to deduct a loss if the amount paid to the Transferor exceeds the amount of eligible credit that the Transferee can ultimately claim. For the Transferee, the Proposed Regulations provide that there is no gross income to the Transferee when claiming an eligible credit if the amount paid for it is less than the amount of such credit transferred and claimed.

Liability for Recapture of Transferred Credits
The Proposed Regulations set forth rules regarding the treatment of any “recapture event” related to any transferred credits that constitute investment tax credits (i.e., an investment tax credit (ITC) recapture event occurs).

Generally, an ITC recapture event occurs if an applicable investment credit property is disposed of or otherwise ceases to be investment credit property with respect to the Transferor (e.g., a loss of use of the eligible property). In the case of any recapture event with respect to the eligible taxpayer Transferor, the Transferee will be responsible for any recapture tax with respect to any ITCs transferred to it and the Transferor must increase the basis of the investment credit property by the recapture amount provided by the Transferee to the Transferor.

Importantly, the Proposed Regulations provide that in the case of a Transferor that is a partnership or S corporation, any recapture liability of a partner or S corporation shareholder during the recapture period resulting from a reduction in the percentage ownership of such partner or S corporation shareholder in the Transferor will not result in any recapture tax liability to the Transferee. Instead, the recapture tax liability resulting from a reduction in the percentage ownership will result in recapture liability only to the disposing partner or S corporation shareholder.

In the case of a recapture event, the Transferor is required to provide written notice of a recapture event to the Transferee with all information necessary to calculate the recapture amount, and the Transferee must provide written notice to the Transferor of the recapture amount. Notwithstanding the foregoing, the Transferor is not required to provide the Transferee any notice of such indirect transfer and any associated recapture liability that does not impact the Transferee. The recapture amount is calculated and taken into account by the Transferee.

Although section 6418 does not specifically address recapture under section 45Q(f)(4), the Proposed Regulations have included provisions related to any recapture of transferred credits under section 45Q that are similar to the requirements applicable to investment credit property.

Excessive Credit Transfer
Section 6418(g)(2) provides that if there is an excessive credit transfer to a Transferee, then the tax imposed on the Transferee is increased in the year of such determination by the amount of the excessive credit transfer plus 20% of the excessive credit transfer as a penalty. The Proposed Regulations provide that the excessive credit penalty will not apply if the Transferee demonstrates to the satisfaction of the IRS that such excessive transfer resulted from reasonable cause, which will be determined based on relevant facts and circumstances. Such determination will include an evaluation of the Transferee’s efforts to determine that the amount of transferred credits is not more than the eligible credit that was determined with respect to the eligible credit property for the taxable year in which the eligible credit was determined and such transferred credits have not been transferred to any other taxpayer. Circumstances that may indicate reasonable cause can include, but are not limited to, the Transferee’s review of the Transferor’s records, the Transferee’s reasonable reliance on third party expert reports, the Transferee’s reasonable reliance on representations from the Transferor, and the Transferee’s review of audited financial statements, if applicable. In the case of multiple transferees, all Transferees will be treated as one Transferee for the purposes of calculating whether there was an excessive transfer and the amount thereof.

Indemnification and Tax Insurance
The Proposed Regulations do not limit the ability of a Transferor and a Transferee to enter into a transfer agreement with respect to the transfer of eligible credits that includes the Transferor indemnifying the Transferee from various tax liabilities associated with the transfer of eligible credits, including the Transferee’s liability for the recapture of tax credits or the Transferee’s liability for an excessive credit transfer. Further, the Proposed Regulations do not expressly address a Transferor and a Transferee obtaining tax insurance to protect the parties against such liabilities.

As evidenced by the analysis above, the Proposed Regulations and guidance on transfer of eligible credits are complex. While the Proposed Regulations remain open for comment and will be further refined and revised before final rulemaking is issued, taxpayers may rely on the Proposed Regulations for taxable years beginning after December 31, 2022, and before the date the final regulations are published in the Federal Register; provided that the taxpayers follow the Proposed Regulations in their entirety and in a consistent manner. In addition, the pre-filing and registration system necessary to transfer the credits from sellers to buyers is not yet up and running. Pillsbury will continue to monitor these developments and provide updates on the key provisions of the Inflation Reduction Act, proposed guidance and final rulemaking.

Pillsbury will be releasing shortly analysis of the Temporary Regulations on Pre-Filing Registration Requirements For Certain Tax Credit Elections released by the U.S. Department of the Treasury and the Internal Revenue Service on June 21, 2023.