On December 15, 2017, the House-Senate Conference Committee released a revised version of the Tax Cuts and Jobs Act (the Final Bill) that is expected to be passed by the House of Representatives and Senate this week and sent to the President for signature. The Final Bill follows the November 16, 2017 passage by the House of Representatives of its version of the Tax Cuts and Jobs Act (the House Bill) and the December 2, 2017 passage by the Senate of its version of the Tax Cuts and Jobs Act (the Senate Bill).
The Final Bill is far-reaching and, when enacted, will make significant changes to how the US taxes individuals, domestic businesses and multinational businesses. This alert focuses on the principal provisions in the Final Bill that impact the energy sector. Energy sector highlights of the Final Bill include:
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No changes to the renewable energy and alternative fuel tax credits;
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Corporate tax rate reduced to 21%;
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Bonus depreciation extended (100% until 2023, reducing to 0% by 2027);
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Net interest deduction disallowed in excess of 30% of adjusted taxable income, but no separate limitation for multinationals;
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Base erosion and anti-abuse tax (BEAT) added but with 80% exclusion for production tax credits (PTCs) and investment tax credits (ITCs);
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Corporate alternative minimum tax (AMT) eliminated;
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Limitation of net operating loss deductions to 80% of taxable income;
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Changes to contributions in aid of construction (CIAC) rules; and
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Individuals permitted to deduct 20% of domestic qualified business income from pass-through entities, including master limited partnerships (MLPs).
Visit the Eversheds Sutherland Tax Reform Law blog for more information and to view additional alerts on the Tax Cuts and Jobs Act as they are released.
House Bill:
Production Tax Credit (PTC): The House Bill proposed two significant changes to the PTC provisions of IRC § 45. First, the inflation adjustment amount for the PTC would have been eliminated for projects for which construction began after the enactment of the legislation. As a result, those projects would have been entitled only to a 1.5 cents per kWh credit as opposed to a 2.4 cents (with continuing adjustments for inflation) per kWh credit. Second, the House Bill stated that for a project to be treated as having begun construction, there must have been “a continuous program of construction” from the date on which construction began until the project is placed in service. The addition of that language suggested that the begun construction requirement could be satisfied only through the actual physical work test, and taxpayers could no longer rely on the 5% safe harbor.
Investment Tax Credit (ITC): The House Bill proposed to repeal the permanent 10% IRC § 48 ITC (for solar projects that are unable to claim the 30%, 26% or 22% ITC) for projects for which construction begins after 2027. In addition, the House Bill extended the ITC for qualified fuel cells, small wind, microturbine, combined heat and power, and thermal energy property. Finally, the House Bill included beginning of construction language similar to that provided for the IRC § 45 PTC.
Fuels Tax Credits: The tax credits for biodiesel and alternative fuels available under IRC §§ 40A, 6426, 6427 and 34 expired at the end of 2016. The House Bill did not reinstate those tax credits.
Nuclear PTC: All of the 6,000 MW for which the nuclear PTC is available under IRC § 45J have been allocated to existing projects. However, as a result of construction delays, not all such allocations are expected to be used. The House Bill provided that after January 1, 2021, Treasury would reallocate any part of the previously allocated 6,000 MW that was not used, first to facilities that did not receive an allocation equal to their full capacity and thereafter to facilities placed in service after such date. Further, certain public utilities would be entitled to transfer their allocation of credits to other specified persons involved with the project.
Residential Energy-Efficient Property: The House Bill proposed to extend this credit for all qualified property placed in service prior to 2022; however, for property placed in service in 2020 and 2021, the proposed tax credit rate would have been 26% and 22%, respectively.
Repeal of Enhanced Oil Recovery (EOR) Credit and Credit for Producing Oil and Gas from Marginal Wells: These credits would have been repealed under the House Bill for all years after 2017.
Senate Bill: The Senate Bill did not modify existing law related to any of the energy tax credits addressed in the House Bill.
Final Bill: The Final Bill follows the Senate Bill and does not modify existing law related to any of the energy tax credits addressed in the House Bill.
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Eversheds Sutherland Observation: The House Bill created significant concern among the wind and solar industries related to reduced PTC amounts and possible changes to the beginning of construction requirement. The Final Bill does not include those provisions. The House Bill also included certain welcomed changes to the nuclear PTC. Those provisions also were not included in the final bill. The tax credits for biodiesel and alternative fuels available under IRC §§ 40A, 6426, 6427 and 34 expired at the end of 2016 and neither the House Bill, the Senate Bill nor the Final Bill reinstate those tax credits. There have been indications that after the Final Bill is enacted, a separate extenders bill might address some or all of the energy tax credits. We expect that any extenders bill, if passed, would not include provisions for the PTC and ITC similar to those in the House Bill. |
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Reduction in Corporate Tax Rates
House Bill: The House Bill generally proposed to reduce the statutory corporate tax rate from 35% to 20%. In connection with the proposed reduction in corporate tax rates, the House Bill included a provision to “normalize” the treatment of excess deferred taxes created by that reduction. Essentially, the bill adopted the average rate assumption method used to reverse the excess deferred taxes created by the Tax Reform Act of 1986. The reduction in corporate tax rates under this bill would have been effective beginning in 2018.
Senate Bill: In this respect, the Senate Bill was nearly identical to the House Bill, also generally reducing the statutory corporate tax rate from 35% to 20% and including a provision to “normalize” the treatment of excess deferred taxes created by the reduction. However, under the Senate Bill, the reduction in corporate tax rates was not effective until 2019.
Final Bill: The Final Bill reduces the statutory corporate tax rate from 35% to 21% effective beginning in 2018. Like both the House Bill and the Senate Bill, in connection with the proposed reduction in corporate tax rates, the Final Bill includes a provision to “normalize” the treatment of excess deferred taxes created by that reduction. Essentially, the Final Bill adopts the average rate assumption method (ARAM) used to reverse the excess deferred taxes created by the Tax Reform Act of 1986.
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Eversheds Sutherland Observation: The Final Bill clarifies an apparent “glitch” in both the House Bill and the Senate Bill by not only imposing a “penalty” equal to the amount of any flow-through in excess of that allowed under ARAM, but also properly treating the excessive flow-through as other than a normalization method of accounting resulting in the loss of accelerated depreciation until the violation is corrected. Secondly, the Final Bill no longer defines “excess deferred taxes” with reference to the Internal Revenue Code of 1986 such that, in the unlikely event that there are further corporate rate reductions, the ARAM provision can be self-executing. |
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Extension of Bonus Depreciation
House Bill: The House Bill proposed to amend IRC § 168(k) by generally increasing bonus depreciation to 100% for property placed in service after September 27, 2017, and before January 1, 2023. The House Bill also would have eliminated the requirement for bonus depreciation that the property be originally placed in service by the taxpayer. The House Bill excluded from these changes any property used by a regulated public utility (or property used in a real property trade or business).
Senate Bill: The Senate Bill also generally would have increased bonus depreciation to 100% for property placed in service after September 27, 2017, and before January 1, 2023. The Senate Bill did not eliminate the requirement that property be originally placed in service by the taxpayer. The Senate Bill would have excluded from its definition of qualified property certain public utility property.
Final Bill: The Final Bill generally increases bonus depreciation:
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To 100% for qualified property placed in service after September 27, 2017, and before January 1, 2023, and
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To 80%, 60%, 40% and 20% for property placed in service in 2023, 2024, 2025 and 2026, respectively.
The Final Bill also eliminates the requirement that property be originally placed in service by the taxpayer, such that bonus depreciation will be available for used property. However, consistent with the House Bill and the Senate Bill, the Final Bill excludes from its definition of qualified property certain public utility property.
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Eversheds Sutherland Observation: The exclusion of public utility property from the bonus depreciation provision is tied to the exclusion of public utilities from the interest expense deductibility limitations discussed below, and avoids forcing utilities to elect one or the other subject to regulatory scrutiny and second-guessing. In recent years, the availability of bonus depreciation has produced net operating losses for many utilities. |
House Bill: Under the House Bill, net interest expense would have been disallowed to the extent that it exceeded 30% of a business’s adjusted taxable income (taxable income computed without regard to interest income and expense, net operating losses (NOLs), depreciation, amortization and depletion). The disallowance did not apply to certain regulated public utilities (or real property trades or businesses). This limitation was calculated and applied at the taxpayer level, so for consolidated groups, the limitation would have applied at the consolidated level.
Interest deductions also could be limited under a provision that applied to multinationals to limit interest deductibility to the extent that the US group is over-leveraged as compared to the global group. This provision applied if the US group’s share of the global group’s net interest expense exceeded 110% of the US group’s share of the global group’s earnings before interest, taxes, depreciation and amortization (EBITDA). The House Bill generally permitted business interest to be carried forward for up to five years.
Senate Bill: Like the House bill, the Senate Bill disallowed deductions for net interest expense in excess of 30% of a business’s adjusted taxable income. Adjusted taxable income was computed without regard to NOLs or deductions under section 199A (but unlike the House Bill, taxable income included depreciation, amortization and depletion). Certain regulated public utilities (along with real property trades or businesses) were exempted from this provision.
Interest deductions for multinationals also could be limited if the US group is over-leveraged as determined by excess domestic indebtedness. The Senate Bill used a different measure of over-leverage than the House Bill. Under the Senate Bill, the interest deduction was limited to the extent the amount by which the total indebtedness of the US members exceeds 110% of the total indebtedness they would hold if the US debt-to-equity ratio was proportionate to the ratio of the worldwide group. The Senate Bill generally permitted indefinite carryforward of disallowed business interest deductions.
Final Bill: The Final Bill generally follows the Senate Bill by disallowing deductions for net interest expense in excess of 30% of a business’s adjusted taxable income, but for taxable years beginning before 2022, adjusted taxable income is computed without regard to depreciation, amortization or depletion. However, the Final Bill does not include the additional limitation on interest deductions for multinationals (i.e., neither the interest/EBITDA limitation of the House Bill nor the debt/equity limitation of the Senate Bill).
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Eversheds Sutherland Observation: The interest expense limitations are not likely to have a material effect on most utilities, particularly since the proposed second limitation on multinationals was not included in the Final Bill. However, questions remain on the flexibility that will be afforded to utilities with respect to the method that may be used to allocate interest between utility and non-utility operations. |
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Base Erosion and Anti-Abuse Tax
House Bill: The House Bill did not include a proposal for a new base erosion and anti-abuse tax.
Senate Bill: The Senate Bill created a new tax (BEAT) that would generally apply to US corporations (other than RICs, REITs or S Corporations) with at least $500 million of annual gross receipts (averaged over a 3-taxable-year period) that make certain cross-border payments to affiliates, generally in excess of 4% of their overall deductions. Under this provision, a taxpayer would be liable for the BEAT in an amount equal to (1) 10% (increased to 12.5% after 2025) of its “modified taxable income,” reduced (through 2025) by the research and development (R&D) credit minus (2) its regular tax liability. Modified taxable income generally means regular taxable income less certain amounts paid or accrued by a taxpayer to a foreign related person for which a deduction (including depreciation) is allowable. The BEAT would apply to payments made or accrued after December 31, 2017.
Final Bill: The Final Bill includes the BEAT provided for in the Senate Bill, but makes a very significant adjustment with respect to ITCs and PTCs, as well as other adjustments. The Final Bill imposes a tax equal to the “base erosion minimum tax amount.” The base erosion minimum tax amount is calculated as follows: (1) 10% of “modified taxable income” over (2) regular tax liability reduced by all tax credits other than the research and development credit and 80% of the ITC, PTC and low income housing credit. Notably:
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Modified taxable income generally means taxable income less deductions claimed (including depreciation) with respect to payments made to a foreign related person other than payments for services without any mark-up.
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For taxable years after 2025, regular tax liability is reduced by all tax credits (including the ITC and PTC).
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The 10% of modified taxable income amount is 5% for 2018 and 12.5% for taxable years after 2025. In addition, the 5%, 10% and 12.5% amounts are increased to 6%, 11% and 13.5%, respectively, for affiliated groups that include a bank or securities dealer.
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The BEAT generally applies to corporations with (1) average annual gross receipts of which for the 3-taxable-year period ending with the preceding taxable year are at least $500 million, and (2) payments to foreign related persons that reduce regular tax liability in computing modified tax liability that exceeds 3% of total deductions (2% for affiliated groups that include a bank or securities dealer).
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Eversheds Sutherland Observation: The Senate Bill had what some viewed as an unintended negative consequence for taxpayers that claimed the ITC or PTC. Under the Senate Bill, ITCs and PTCs fully reduced regular tax liability and therefore more readily could cause tax equity investors and other renewable energy investors to be subject to tax under the BEAT provisions, thereby effectively reducing the value of the ITCs or PTCs. The Final Bill makes significant strides to resolve that concern for many taxpayers by allowing 80% of the ITCs and PTCs to be used in the calculation of any additional tax under the BEAT provisions, although several concerns remain including (1) whether any unused tax credits can be carried forward under the BEAT provisions, and (2) absent further legislation, the inability to use the ITCs or PTCs in the BEAT calculations after 2025 (particularly for the PTC). Taxpayers will need to calculate, based on their particular circumstances, whether they will be subject to an additional tax under the BEAT provisions, even with the allowance of 80% of the claimed ITCs and PTCs, and consider whether the provisions will impact any tax equity transactions or the availability of tax equity investors. |
House Bill: The House Bill repeals the corporate AMT and makes prior-year AMT credits refundable.
Senate Bill: The Senate Bill did not repeal the corporate AMT.
Final Bill: The Final Bill follows the House Bill by repealing the corporate AMT and making prior-year AMT credits refundable.
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Eversheds Sutherland Observation: In a last-minute amendment, the Senate retained the corporate AMT in the Senate Bill. The retention of the corporate AMT was of great concern to the renewable energy industry because it reduced the value of the PTC in light of the 4-year AMT limitation on claiming the PTC and the interplay between the other changes proposed in the Senate Bill (including the 20% corporate tax rate) and the AMT. The repeal of the corporate AMT in the Final Bill eliminates that concern. |
House Bill: Taxpayers would be permitted to offset only 90% of their taxable income with NOLs (similar to the current corporate AMT). NOLs could be carried forward indefinitely and would be increased by an interest factor intended to preserve their value. However, NOLs would generally not be permitted to be carried back.
Senate Bill: The Senate Bill would generally limit NOL deductions to 90% of taxable income (80% after 2023) and would permit post-2017 NOLs to be carried forward indefinitely. Post-2017 NOLs would generally not be permitted to be carried back.
Final Bill: The Final Bill generally follows the Senate Bill, but limits new NOL deductions to 80% of taxable income for all years.
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Eversheds Sutherland Observation: The NOL changes are effective for losses arising in taxable years ending after December 31, 2017 and therefore generally should not impact the treatment of prior NOLs. |
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Contributions in Aid of Construction (CIAC)
House Bill: Under current law, non-shareholder contributions to capital may or may not be includible in the taxable income of the recipient corporation. The House Bill proposes to revise these rules so that contributions to capital generally would be includible in the gross income of the recipient corporation to the extent that the fair market value of the contributed assets exceeds the fair market value of any stock that is issued in exchange for such contributed assets.
Senate Bill: The Senate Bill does not modify existing law regarding contributions to capital.
Final Bill: The Final Bill retains section 118(a), which provides that the gross income of a corporation does not include any contribution to the capital of the taxpayer, but replaces section 118(b), which currently provides that the term “contribution to the capital of the taxpayer” does not include any “contribution in aid of construction as a customer or potential customer.” Under the Final Bill, new section 118(b) states that the term “contribution to the capital of the taxpayer” does not include (1) any contribution in aid of construction or any other contribution as a customer or potential customer, and (2) any contribution by any governmental entity or civic group (other than a contribution made by a shareholder as such). New section 118(c) directs Treasury to issue regulations or other guidance for determining whether any contribution constitutes a contribution in aid of construction.
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Eversheds Sutherland Observation: A common industry issue is whether equipment transferred to a utility is includible in the utility’s taxable income under IRC § 118 and IRS guidance. The IRS has issued a series of Notices, including most recently Notice 2016-36, to address whether such transfers are includible in the income of the recipient utility. Under the Final Bill, it is expected that further guidance will be issued. In that regard, the Joint Explanatory Statement of the Conference Committee released with the Final Bill states that the “conference agreement follows the policy of the House bill.” In future guidance, Treasury will need to reconcile that statement with the changes made to section 118(b) and to Notice 2016-36. Regulations could help provide certainty given the generally muddled state of case law and the challenges of issuing guidance in the form of limited scope notices. Until such regulations are issued, however, utilities are likely to continue to require tax gross-ups from contributors of property in any context not clearly deemed non-taxable under existing Notices. |
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Partnership and Other Pass-Though Income (Including PTP/MLP Income)
House Bill: The House Bill created a maximum 25% tax rate for certain qualified business income of individuals from partnerships, S corporations or sole proprietorships. Qualified business income generally would have included all net business income from passive business activities plus the capital percentage of net business income from active business activities, reduced by certain net business losses for the current year and by carryover business losses.
For any active business activity, a taxpayer generally would have been deemed to have a capital percentage of 30% unless the taxpayer were to elect to use its applicable percentage for such activity, which, for any taxable year, would have been calculated by dividing (1) the taxpayer’s deemed return on capital from the activity for such year (based, very generally, on the taxpayer’s adjusted basis in the activity at the end of the year, multiplied by the short-term applicable federal rate plus 7%), by (2) the taxpayer’s net business income from the activity for such year.
The special maximum 25% rate generally would not have applied to specified service activities. For these activities, the taxpayer’s capital percentage generally would have been deemed to be zero. However, with respect to any capital-intensive specified service activity, which generally would have included any specified service activity for which the taxpayer’s applicable percentage (as discussed above) was at least 10%, the taxpayer would have been permitted to elect to utilize a capital percentage equal to the taxpayer’s applicable percentage for such activity.
Senate Bill: Under the Senate Bill, an individual taxpayer would have been allowed as a deduction an amount equal to the lesser of (1) the “combined qualified business income amount” of the taxpayer, or (2) 23% of the taxable income of the taxpayer for the year, excluding net capital gains. A taxpayer’s combined qualified business income amount generally would have been the sum of (i) 23% of the taxpayer’s qualified REIT dividends, qualified cooperative dividends, and qualified publicly traded partnership income, plus (ii) a separate deduction amount computed for each qualified trade or business of the taxpayer. The separate deduction amount for any qualified trade or business of the taxpayer would have been the lesser of:
(1) 23% of the taxpayer’s qualified business income with respect to the trade or business, or
(2) 50% of the taxpayer’s allocable or pro rata share of the W-2 wages with respect to the trade or business (subject to a phase-in such that the W-2 wage limitation would have applied to any taxpayer whose taxable income was greater than $500,000 for married couples filing jointly or $250,000 for other individuals, in each case, as adjusted for inflation).
Qualified business income generally would have meant the net amount of qualified items of income, gain, deduction and loss with respect to any qualified trade or business of the taxpayer carried on as a sole proprietorship or through a partnership or an S corporation (but excluding any items taken into account in computing qualified REIT dividends, qualified cooperative dividends, and qualified publicly traded partnership income). A qualified trade or business generally would have included all trades and businesses of the taxpayer other than (i) the trade or business of performing services as an employee, and (ii) certain specified service trades or businesses (subject to a phase-in such that the exception for specified service trades or businesses would have applied to any taxpayer whose taxable income was greater than $500,000 for married couples filing jointly or $250,000 for other taxpayers, in each case, as adjusted for inflation).
Final Bill: The Final Bill generally follows the Senate Bill, but includes several important changes. Among other things, under the Final Bill, the deduction would be reduced from 23% to 20%. Further, the scope of the deduction would be expanded to apply to individuals, trusts and estates. Moreover, the W-2 wage limitation that would apply in computing the separate deduction amount for any qualified trade or business of the taxpayer would be equal to the greater of (1) 50% of the taxpayer’s allocable or pro rata share of the W-2 wages with respect to the trade or business, or (2) the sum of (i) 25% of the taxpayer’s allocable or pro rata share of the W-2 wages with respect to the trade or business and (ii) 2.5% of the taxpayer’s share of the unadjusted basis immediately after acquisition of all qualified property, which generally would include certain depreciable property held by and used in the trade or business in the production of qualified business income. The Final Bill would modify the definition of specified service trade or business and would also modify the phase-ins applicable to the W-2 wage limitation and the specified service trade or business exception so that these phase-ins would apply to any taxpayer whose taxable income exceeds $315,000 for married couples filing jointly or $157,500 for other taxpayers, in each case, as adjusted for inflation.
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Eversheds Sutherland Observation: Under the Final Bill, a taxpayer’s qualified business income deduction would be computed taking into account any qualified publicly traded partnership income of the taxpayer, which generally would include the taxpayer’s allocable share of each qualified item of income, gain, deduction and loss from a publicly traded partnership excepted from treatment as a corporation under IRC § 7704(c), plus any gain recognized by the taxpayer from the disposition of an interest in such a partnership to the extent that such gain would be treated as an amount realized from the sale or exchange of property other than a capital asset under IRC § 751(a). Moreover, the W-2 wage limitation would not apply to the taxpayer’s qualified publicly traded partnership income. Accordingly, non-corporate taxpayers owning interests in master limited partnerships, including energy-sector master limited partnerships, generally would be eligible for the qualified business income deduction. |
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Section 199 Domestic Production Deduction
House Bill: The House Bill repeals the deduction for domestic production activities.
Senate Bill: The Senate Bill repeals the deduction for domestic production activities for taxpayers other than C corporations.
Final Bill: The Final Bill repeals the deduction for domestic production activities.
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