On January 2, 2013, President Obama signed H.R. 8, the American Taxpayer Relief Act of 2012, into law, which reduced some of the tax increases scheduled to take effect on January 1, extended a number of expiring tax provisions, and put off fiscal cliff sequestration for two months. This alert summarizes some of the new law’s provisions that may be of interest to energy companies and their financiers.
1. Production Tax Credit
The production tax credit (PTC) was scheduled to expire for wind facilities not placed in service before the end of 2012 and for most other renewable resources not placed in service before the end of 2013. The PTC applies to facilities that generate electricity using qualified energy resources, which include wind, closed-loop biomass, open-loop biomass, geothermal energy, solar energy, small irrigation power, municipal solid waste, qualified hydropower production, and marine and hydrokinetic renewable energy. Electricity produced from qualified energy resources must be sold by the taxpayer to an unrelated person. Since 2009, taxpayers have also been able to claim a 30% investment tax credit (ITC) in lieu of the PTC (or cash grants).
H.R. 8 extends and modifies the expiration dates for the renewable electricity production credit and the 30% investment credit in lieu of such production credit. The proposal extends the wind credits (production and investment) for one year (through December 31, 2013). In addition, the expiration date for certain renewable power facilities (including wind facilities) was modified such that qualified facilities or property will be eligible for the renewable electricity production credit, or the ITC in lieu of such credit, if the construction of such facilities or property begins before January 1, 2014. There appears to be no other placed-in-service deadline for projects which meet the new “begun construction” deadline. Can projects that begin construction in 2013 begin collecting PTCs or ITCs if they are, for example, placed in service in 2015?, 2020?
Regarding wind facility construction, much will depend on how the Treasury Department interprets the meaning of “commencing construction.” A similar concept applied to the ability of solar projects to claim the cash grant in lieu of ITC under Section 1603 of the American Recovery and Reinvestment Act of 2009 (ARRA). The guidelines issued by the Treasury Department regarding “begun construction” applications required that an owner either have started physical work of a significant nature on the site (or offsite) or that the owner have paid or incurred at least 5% of the cost of construction. Many solar projects rushed to qualify for these begun construction conditions by the end of 2011. It is not clear whether the generous “begun construction” rules that applied for cash grant purposes pursuant to Section 1603 of ARRA will be used for the new extension. Wind farms, in particular, were able to take advantage of a provision in Treasury’s 2009 cash grant rules that allowed wind producers to treat multiple towers as a single piece of property, which would not otherwise have been the case.
H.R. 8 did not include a special rule that Waste-to-Energy (WTE) facilities and other baseload renewable energy sources had asked for, which would have expanded the new “begun construction” provision to include a “binding contract for fuel (trash)” rule. WTE providers have argued that WTE facilities take even longer than other renewable resources to permit and build. H.R. 8 also modified the definition of municipal solid waste to exclude “commonly recycled” paper that has been segregated from such waste for purposes of the WTE PTC.
2. Biodiesel and Agri-Biodiesel Tax Credits The income tax credit for biodiesel fuels (the “biodiesel fuels credit”) expired at the end of 2011. The biodiesel fuels credit is the sum of three credits: (1) the biodiesel mixture credit; (2) the biodiesel credit; and (3) the small agri-biodiesel producer credit. The biodiesel fuels credit is treated as a general business credit and is includible in gross income. The biodiesel fuels credit is coordinated to take into account benefits from the biodiesel excise tax credit.
Biodiesel is made up of esters of long-chain fatty acids derived from plant or animal matter. Agri-biodiesel is biodiesel derived solely from virgin oils including oils from corn, soybeans, sunflower seeds, cottonseeds, canola, crambe, rapeseeds, safflowers, flaxseeds, rice bran, mustard seeds, camelina, or animal fats. The biodiesel credit is only available to certified end users or ultimate retailers, and can be an excise tax credit, an income tax credit, or a cash refund (to the extent the taxpayer has no excise tax liability). The credit expired at the end of 2011.
H.R. 8 extends the income tax credit, excise tax credit, and payment provisions for biodiesel and renewable diesel for two years (through December 31, 2013). The proposal is retroactively effective for sales and use during 2012.
3. Alternative Fuel and Alternative Fuel Mixture Credits
The Internal Revenue Code (“Code”) provides two 50 cents per gallon excise tax credits with respect to alternative fuels: the alternative fuel credit and the alternative fuel mixture credit. The term “alternative fuel” means liquefied petroleum gas, P Series fuels, compressed or liquefied natural gas, liquefied hydrogen, liquid fuel derived from coal through the Fischer-Tropsch process (“coal-to-liquids”), compressed or liquefied gas derived from biomass, or liquid fuel derived from biomass. This term does not include ethanol, methanol, or biodiesel. The alternative fuel mixture credit is based on alternative fuel used in producing an alternative fuel mixture for sale or use in a trade or business of the taxpayer. An “alternative fuel mixture” is a mixture of alternative fuel and taxable fuel that contains at least 1/10 of 1% taxable fuel. The mixture must be sold by the taxpayer producing such mixture to any person for use as a fuel, or used by the taxpayer producing the mixture as a fuel. The credits generally expire after December 31, 2011 (September 30, 2014 for liquefied hydrogen).
The proposal extends the alternative fuel credit, alternative fuel mixture credit, andrelated payment provisions (for non-hydrogen fuels) for two additional years (through December 31, 2013). Restrictions were added, however, on the ability of taxpayers to claim cash refunds (as opposed to excise tax credits) for these credits.
4. Cellulosic Biofuels Credit
Facilities producing cellulosic biofuel were entitled to claim a $1.01 per gallon production tax credit on that fuel produced before December 31, 2012. H.R. 8 extends this production tax credit for an additional year, meaning that the credit applies to all cellulosic biofuel produced until December 31, 2013. The H.R. 8 also expands the definition of qualified cellulosic biofuel production to include algae-based fuel.
5. Bonus Depreciation Extended
As part of economic stimulus packages going back to 2008, businesses were allowed to take first-year depreciation deductions for the cost of capital expenditures equal to 50% of the cost of the depreciable property in addition to the normal depreciation taken over time. The 50% bonus depreciation was applicable from 2008 to 2010. The 2010 Tax Relief Act increased bonus depreciation to 100% for 2011, meaning that businesses were able to deduct the entire cost of qualifying equipment in the year it was placed in service and the rate went back to 50% for qualifying equipment placed in service in 2012. This bonus depreciation provision was set to expire at the end of 2012. The capital equipment that goes into the construction of power plants generally speaking was eligible for this bonus depreciation, presenting power developers with an important financial incentive for power plant construction. Placing a project in service by the end of 2012 so that the capital equipment would be eligible for this bonus depreciation was an important consideration in the completion dates of construction contracts and in contracts for the purchase and sale of power generation projects under development.
H.R. 8 extends bonus depreciation for qualifying property purchased and placed in service on or before December 31, 2013--a one-year extension of the law in effect in 2012. For certain assets that are depreciated for periods more than ten years, such as power generation equipment, the extension is for two years. Bonus depreciation of 50% for longer-lived equipment will be available for qualifying property purchased and placed in service on or before December 31, 2014.
Thus, H.R. 8 in effect extends this important incentive for power plant development for two years. There is no change, however, to the general rules regarding how the use of the investment tax credit affects the depreciable basis of property, namely that the property’s basis will be reduced by the amount of the investment tax credit, thus reducing the amount of first-year bonus depreciation that may be claimed. Bonus depreciation itself will reduce the property’s basis and thereby reduce the amount of depreciation deducted after the first year.
This provision also decouples bonus depreciation from allocation of contract costs under the percentage of completion accounting method rules for assets with a depreciable life of seven years or less that are placed in service in 2013. For regulated utilities, the provision clarifies that it is a violation of the normalization rules to assume a bonus depreciation benefit for ratemaking purposes when a utility has elected not to take bonus depreciation.
6. Dividends Taxation to Remain at Capital Gain Rates
The investor-owned utilities industry was very concerned that the expiration of the Bush tax cuts would put the maximum tax rate on dividend income back to 40% instead of the 15% in effect in 2012, which was also the long-term capital gain rate. H.R. 8 raises the long-term capital gains rate to 20% for individuals with income over $400,000 and couples earning over $450,000, but sets the maximum tax rate on dividend income at the same 20% (plus, in each case, the 3.8% Medicare tax to finance the health care law for those higher incomes). Since many investor-owned utilities are financed with roughly equal amounts of debt and equity, industry representatives were concerned that there would be a large sell off of dividend-producing utility stocks that would have depressed their prices and thus raised the cost of the utilities’ financing, which they believed would have to be passed on to consumers.
7. Delay of Sequestration
The provisions of H.R. 8 that delay the planned budget sequestrations from January 2, 2013 to March 1, 2013 will have a positive impact on one aspect of renewable energy finance that was of concern to power developers and their financiers. Section 1603 of the ARRA allowed owners of most types of renewable power projects to receive a cash grant of 30% of the eligible costs of a project in lieu of the ITC. Since the eligibility deadline for this cash grant related to projects having commenced construction or incurred certain eligible costs by the end of 2011, and that the deadline for submitting applications was October 1, 2012, a number of cash grant applications are now pending and awaiting approval by the Treasury Department. The general sequestration provisions of the fiscal cliff legislation that would have taken effect on January 2, 2013 would have reduced the amount of cash project owners were slated to receive by 7.6%. This would have had a serious impact on the economics of some projects, especially ones that had received bridge financing in anticipation of receiving the full 30% grant.
For now, cash grants will be spared sequestration for at least two months, and grants approved and disbursed by the Treasury Department before March 1, 2013 will be at their full 30% level. Whether cash grants will be subject to sequestration after March 1, 2013 depends on how the larger sequestration question is resolved by Congress before then.
8. Utility Sales of Transmission Assets
Section 451(i) of the Code permits taxpayers to elect to recognize gain from qualifying electric transmission transactions ratably over an eight-year period beginning in the year of sale if the amount realized from such sale is used to purchase exempt utility property within the applicable period. If the amount realized exceeds the amount used to purchase reinvestment property, any realized gain is recognized to the extent of such excess in the year of the qualifying electric transmission transaction.
A qualifying electric transmission transaction is the sale or other disposition of property used by a qualified electric utility to an independent transmission company prior to January 1, 2012. A qualified electric utility is defined as an electric utility, which as of the date of the qualifying electric transmission transaction, is vertically integrated in that it is both: (1) a transmitting utility (as defined in the Federal Power Act) with respect to the transmission facilities to which the election applies; and (2) an electric utility (as defined in the Federal Power Act).
H.R. 8 extends the treatment under the present-law deferral provision to sales or dispositions by a qualified electric utility that occur prior to January 1, 2014. The extension provision applies to dispositions after December 31, 2011.
9. Looking Forward
The signing of H.R. 8 into law by President Obama will mark the end of the first of a series of fiscal cliffs. The 113th Congress, which was sworn in at noon on January 3, 2013, will confront three additional cliffs: first, is the debt ceiling, which Treasury Secretary Timothy Geithner notified Congress on December 31, 2012 had been reached. Congress will have barely two months to resolve the debt ceiling. Second, is the sequester created by the Budget Control Act, which was to be triggered on January 2, 2013, but delayed until March 1, 2013 by H.R. 8. Congress will have to come up with an additional $1.2 trillion in budget cuts over the next nine years or delay the sequester yet again. Third, Congress has to complete the Fiscal Year 2013 appropriations, which are currently being funded under a Continuing Resolution which also expires on March 31, 2013.
In addition, it should be noted that many members of the 112th Congress grudgingly agreed to accept the energy tax extenders included in H.R. 8 in anticipation of a major effort to reform the tax code in the 113th Congress. Reform of the tax code during the 113th Congress could well include a significant reformulation of tax subsidies currently available for energy production. Among the proposals put forward during the 112th Congress and likely to resurface during the tax reform debate in the 113th Congress are: