On June 14, 2023, the Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) issued guidance on several topics related to tax credit monetization under the Inflation Reduction Act of 2022 (IRA), including proposed regulations related to transferability and elective pay, proposed regulations concerning the elective payment election of the advanced manufacturing investment credit under the Creating Helpful Incentives to Produce Semiconductors (CHIPS) Act of 2022, and temporary regulations setting forth mandatory information and registration requirements for taxpayers planning to make a transferability or elective payment election under the IRA and CHIPS Act.

This legal alert discusses proposed regulations regarding the new transferability regime (Proposed Regulations) under section 6418 of the Internal Revenue Code of 1986, as amended (the Code). We previously issued a legal alert providing an overview of all of the guidance with our preliminary observations. Future alerts with our analysis of the other pieces of guidance are forthcoming.

The Proposed Regulations describe rules for the election to transfer eligible credits in a taxable year, include definitions and special rules applicable to partnerships and S corporations, provide rules related to excessive credit transfer or recapture events and outline required pre-filing registration process. They include commentary requested in Notice 2022-50, on potential issues related to transferability.

Key Takeaways

The Proposed Regulations provide long-awaited guidance on the new transferability regime and, increased activity in the market for energy tax credits is expected going forward. Key takeaways from the new guidance include:

• A taxpayer must transfer the entire (or portion of the entire) eligible credit, and may not separately transfer base and bonus credit amounts.
• Credits are permitted to be transferred once, however, an allocation of a transferred specified credit portion to a direct or indirect owner of a pass-through transferee taxpayer does not violate the no second transfer rule.
• Once made, the election to transfer an eligible credit is irrevocable.
• Transfer of eligible credits to multiple transferees is permitted, subject to certain conditions.
• All of the consideration paid by a transferee taxpayer must be paid in cash (as defined by the Proposed Regulations); inclusion of any amount of non-cash consideration will cause the entire transfer election to fail.
• The risk of recapture generally falls on the transferee taxpayer with some exceptions, however, contractual indemnification and tax insurance is not prohibited.

Procedural Matters

Taxpayers may rely on the Proposed Regulations for taxable years beginning after December 31, 2022, and before final regulations are published in the Federal Register, provided the Proposed Regulations are followed in their entirety and in a consistent manner.

Written comments on the Proposed Regulations should be submitted by August 14, 2023 and requests to speak with discussion outlines are due on or before August 14, 2023. A public hearing will be held on August 23, 2023.

Background – Transferability (Section 6418)

Section 6418 provides a new tax credit transferability regime that enables taxpayers to buy and sell energy tax credits under certain circumstances. Transferability is an alternative to traditional tax equity structures, which were formerly the only means for monetizing tax credits. Under section 6418, “eligible taxpayers” (as defined by the Proposed Regulations) may elect to transfer certain “eligible credits” to unrelated taxpayers rather than applying them against their own federal income tax liabilities. Eligible credits for transfer include:

• Credits for alternative fuel vehicle refueling property (section 30C);
• Renewable electricity production credits (production tax credits) (section 45(a));
• Credits for carbon oxide sequestration (section 45Q(a));
• Zero-emission nuclear power production credits (section 45U(a));
• Clean hydrogen production credits determined (section 45V(a));
• Advanced manufacturing production credits (section 45X(a));
• Clean electricity production credits (section 45Y(a));
• Clean fuel production credits determined (section 45Z(a));
• Energy credits (investment tax credits) (section 48);
• Qualifying advanced energy project credits (section 48C); and
• Clean electricity investment credits (section 48E).

An eligible taxpayer may transfer a “specified credit portion” of an eligible credit, which may include the entire credit, by making a transfer election on its original tax return for the taxable year for which the credit is determined by the due date of such return.

A “transferee taxpayer” takes the transferred eligible credit into account in its first tax year ending with, or after, the eligible taxpayer’s tax year with respect to which the transferred eligible credit was determined. The consideration paid by a transferee taxpayer:

• shall be required to be “paid in cash,”
• shall not be includible in gross income of the eligible taxpayer, and
• shall not be deductible by the transferee taxpayer.

The Proposed Regulations also provide further clarification on additional special rules applicable to the transferability regime under section 6418(g), including:

• Authorization for Treasury to impose pre-filing registration requirements for purposes of preventing duplication, fraud, improper payments, or excessive payments.
• In the event of an “excessive credit transfer”, there is an imposition of a 20% tax on such excessive credit transfer (regardless of whether the transferee taxpayer would have been subject to tax).
• Basis reduction rules.
• Recapture rules.

Proposed Rules and Definitions Related to the Transfer of Eligible Credits

The Proposed Regulations provide generally that an “eligible taxpayer” may elect to transfer any specified portion of an “eligible credit” determined with respect to any “eligible credit property” of such eligible taxpayer for any taxable year to a “transferee taxpayer”. The Proposed Regulations then define several key terms used in the statute and regulations, including:

“Eligible Taxpayer” – any taxpayer other than those described in the statute and proposed regulations pertaining to elective pay.

“Eligible Credit” – includes those renewable energy credits identified in section 6418(f)(1)(A) (see list above). The Proposed Regulations clarify that the entire amount of any “eligible credit” is separately determined with respect to each single eligible credit property of the eligible taxpayer and includes any bonus credit amounts determined with respect to that single eligible credit property.

“Eligible Credit Property” – the unit of property of an eligible taxpayer with respect to which the amount of an eligible credit is determined. The Proposed Regulations provide specific information regarding the appropriate unit of measure related to each individual credit as well.

“Transfer Election” – an election under section 6418(a) to transfer to a transferee taxpayer a specified portion of an eligible credit determined with respect to an eligible credit property.

“Specified Credit Portion” – a proportionate share (including all) of an entire eligible credit determined with respect to an eligible credit property of the eligible taxpayer that is specified in a transfer election. This amount must reflect a proportionate share of each bonus credit amount that is taken into account in calculating the entire amount of the eligible credit determined with respect to a single eligible credit property. The preamble to the Proposed Regulations notes that this definition precludes taxpayers from transferring bonus credit amounts related to an eligible credit property separately from the “base” eligible credit determined with respect to that property.

“Paid in Cash” – a payment made in United States (US) dollars. The definition contemplates limiting the manner in which US dollars may be transferred in connection with a transfer election to payments by cash, check, cashier’s check, money order, wire transfer, ACH transfer, or other bank transfer of immediately available funds. The Proposed Regulations also would provide a safe harbor timing rule to allow for certainty as to the treatment of such payments of US dollars made during a prescribed time period. The Proposed Regulations also provide that a contractual commitment to purchase eligible credits in advance of the date a specified credit portion is transferred satisfies the paid in cash requirement, so long as all cash payments are made during the applicable time period.

Proposed Regulations Related to Making a Transfer Election

The Proposed Regulations generally provide that if a valid transfer election is made by an eligible taxpayer for any taxable year, the transferee taxpayer specified in such election (and not the eligible taxpayer) is treated as the taxpayer for purposes of the Code with respect to the specified credit portion. The Proposed Regulations provide additional rules addressing specific scenarios to effect the general transferability regime, including:

Multiple Transferees – there is no limitation for an eligible taxpayer transferor in respect of the number of transfer elections it is permitted to make or the number of transferee taxpayers to which it is permitted to transfer a specified credit portion. However, the aggregate amount of a specified credit portion must not exceed the amount of the eligible credit to be transferred with respect to an eligible credit property. Transfer to multiple transferees must still comply with the requirement that base and bonus credits may not be transferred separately.

Different Ownership Arrangements – the Proposed Regulations address when eligible taxpayers are permitted to elect a transfer in certain ownership situations:

• Disregarded entity wholly owned by an eligible taxpayer – the eligible taxpayer makes the transfer election.
• Undivided ownership interests – if eligible credit property is directly owned through a tenancy-in-common arrangement, or through an organization that has properly elected out of subchapter K, each co-owner’s or member’s undivided ownership share of the eligible property will be treated as a separate eligible credit property owned by such co-owner or member. Each co-owner or member is permitted to make a separate transfer election for its respective portion of the credit.
• Members of a consolidated group – a member corporation must make the transfer election.
• Partnership or S corporation – with respect to any eligible credit property held directly by such partnership or S corporation, the partnership or S corporation makes the transfer election.

Circumstances Where No Transfer Election Can Be Made – The Proposed Regulations identify three circumstances where no transfer election can be made:

• No transfer election is permitted with respect to any amount of an eligible credit determined based on progress expenditures that is allowed pursuant to rules similar to the rules of section 46(c)(4) and (d) (as in effect on the day before the date of the enactment of the Revenue Reconciliation Act of 1990).
• No transfer election is permitted when an eligible taxpayer receives any consideration other than cash in connection with the transfer of a specified credit portion (i.e., if any consideration is other than cash, the transfer election is disallowed).
• No transfer election is permitted when eligible credits are not determined with respect to an eligible taxpayer (i.e., where the eligible taxpayer owns the underlying eligible credit property or, if ownership is not required, otherwise conducts the activities giving rise to the underlying eligible credit).

Manner and Due Date of Making a Transfer Election – Although section 6418 generally allows an eligible taxpayer to transfer an eligible credit to a transferee taxpayer, the statute does not provide for the relevant unit of measurement for an election to transfer eligible credits. The Proposed Regulations fill this critical gap by requiring an eligible taxpayer to make a transfer election to transfer a specified credit portion on the basis of a single eligible credit property. In other words, an eligible taxpayer that determines eligible credits with respect to two eligible credit properties would need to make a separate transfer election for each property. Treasury and IRS expressly seek further comments on this issue in the Proposed Regulations.

The Proposed Regulations also provide that a transfer election would be required for each taxable year an eligible taxpayer elects to transfer a specified credit portion with respect to such eligible credit property during the 10-year period beginning on the date such eligible credit property was originally placed in service.

To make a valid transfer election, an eligible taxpayer must include the following in filing its return:

• a properly completed relevant source credit form for the eligible credit;
• a properly completed Form 3800, including the registration number received during the required pre-filing registration;
• a schedule attached to the Form 3800 showing the amount of eligible credit transferred for each eligible credit property;
• a “transfer election statement” (i.e., a written document that describes the transfer of a specified credit portion between an eligible taxpayer and transferee taxpayer, as described more thoroughly in the Proposed Regulations); and
• any other information related to the election specified in guidance.

The transfer election statement may generally be completed any time after the eligible taxpayer and transferee taxpayer have sufficient information to prepare it. However, a transfer election statement cannot be completed for any taxable year after the earlier of (1) the filing of the eligible taxpayer’s return for the taxable year for which the specified credit portion is determined with respect to the eligible taxpayer, or (2) the filing of the return of the transferee taxpayer for the year in which the specified credit portion is taken into account. Further, an election to transfer any specified credit portion would need to be made not later than the due date (including extensions of time) for the tax return for the taxable year for which the eligible credit is determined.

Election Limitations – the Proposed Regulations include certain limitations on making an election under section 6418:

• Once made, an election to transfer an eligible credit is irrevocable.

• “No second transfer rule” – A transferee taxpayer of any specified credit portion may not make a second transfer under section 6418 with respect to any amount of such transferred credit. An allocation of a transferred specified credit portion to a direct or indirect owner of a pass-through entity would not be considered a transfer for the purposes of this prohibition. Conversely, an arrangement where the tax ownership of a specified credit portion transfers first, from an eligible taxpayer to a dealer or intermediary and then, ultimately, to a transferee taxpayer would violate the no second transfer rule.

Determining the Amount of Eligible Credit that is Transferable – The Proposed Regulations generally apply rules from the Code that relate to determination of tax credits to the transferor, including the limitations in sections 49 and 50(b) of the Code, which can limit the transferable eligible credits determined with respect to a single eligible credit property owned by the eligible taxpayer. The Proposed Regulations distinguish rules that impact the amount of credit determined or the credit base (and thus, the amount of eligible credit that can be transferred) from rules that impact a taxpayer’s ability to claim a particular eligible credit against its tax liability. Rules that impact a transferor taxpayer’s ability to claim a particular eligible credit against its own tax liability do not limit the amount of an eligible credit that an eligible taxpayer can transfer. Rather, those rules apply to the transferee taxpayer who claims the eligible credit after transfer.

Payments Made in Connection with Transfer – The Proposed Regulations clarify the treatment of payments made by a transferee taxpayer to an eligible taxpayer in connection with the transfer of an eligible credit. As an initial matter, an amount paid by a transferee taxpayer to an eligible taxpayer is consideration for a transfer of a specified credit portion only if it (1) is paid in cash, (2) directly relates to the specified credit portion, and (3) is not related to an “excessive credit transfer.”

Amounts paid in connection with a transfer election by a transferee taxpayer are not includible in the gross income of an eligible taxpayer and are not deductible by the transferee taxpayer.

Anti-Abuse Rules – The Proposed Regulations include a mechanism to disallow the election and transfer of an eligible credit under section 6418, or otherwise recharacterize a transaction’s income tax consequences, in circumstances where the parties to the transaction have engaged in the transaction with the principal purpose of avoiding tax liability beyond the intent of section 6418.

• a properly completed Form 3800, taking into account a transferred eligible credit as a current general business credit, including all registration number(s) related to the transferred eligible credit;
• the transfer election statement; and
• any other information related to the transfer election specified in guidance.

Additionally, the passive activity limitation loss rules of section 469 would apply to transferee taxpayers’ transferred credits, based on passive activity of the transferee.

The Proposed Regulations do not address the tax treatment of transaction costs or whether a transferee taxpayer is permitted to deduct a loss if the amount paid to an eligible taxpayer exceeds the amount of the eligible credit that the transferee taxpayer can ultimately claim. Treasury and IRS expressly request comments on such topics in the preamble to the Proposed Regulations.

Proposed Regulations Related to Partnerships/S Corporations

The Proposed Regulations provide that a partnership or an S corporation may qualify as an eligible taxpayer or as a transferee taxpayer. In general, a transfer election is made at the entity level and no election by any partner or shareholder is allowed. Additionally, a partnership that is an indirect or direct partner of a transferor partnership (an upper-tier partnership) is not an eligible taxpayer with respect to an eligible credit allocated to it by a transferor partnership.

The Proposed Regulations also clarify that language in section 6418(c) requiring an eligible credit property to be “held directly” by a transferor partnership or transferor S corporation allows for such eligible credit property to be owned by an entity disregarded as separate from the transferor partnership or S corporation.

Partnerships and S corporations would generally make a transfer election for a specified credit portion in the manner provided in the Proposed Regulations for other eligible taxpayers.

Special Recapture Rules – In general, recapture under section 50(a) occurs when the an investment credit property for which an eligible credit was determined is disposed of or otherwise ceases to be investment credit property with respect to the eligible taxpayer (i.e., the transferor). In the partnership or S corporation context, recapture of ITC eligible credits occurs when the partnership or S corporation disposes of the ITC property. However, the Proposed Regulations also address recapture when a partner or S corporation shareholder disposes of its interest or shares. Under the Proposed Regulations, a partner or S corporation shareholder’s disposition of its interest or shares does not trigger recapture under sections 1.47-4(a)(2) or 1.47-6(a)(2) at the partnership/S corporation level, or by the transferee. However, the partner or S corporation shareholder is subject to recapture, which is calculated based on their pro rata share of the basis of the section 38 property that was the source of the transferred credit.

Rules Applicable to Transferor/Transferee Partnerships – Any amount received as consideration for a transfer of eligible credits by a transferor partnership is treated as tax-exempt income for purposes of section 705, increasing a partner’s basis in its partnership interest. A partner’s distributive share of such tax-exempt income is based on such partner’s distributive share of the otherwise eligible credit for each taxable year. Any tax-exempt income resulting from the receipt of consideration for the transfer of a specified credit portion by a transferor partnership is treated as arising from an investment activity and not from the conduct of a trade or business. Thus, such income 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).

With respect to transferee partnerships, the Proposed Regulations clarify that allocations of a transferred specified credit portion by a transferee partnership are not a violation of the no second transfer rule. Cash payments by a transferee partnership are treated as section 705(a)(2)(B) expenditures. Each partner’s distributive share of any transferred specified credit portion is based on such partner’s distributive share of the section 705(a)(2)(B) expenditures used to fund the purchase of such transferred specified credit portion.

Rules Applicable to Transferor/Transferee S Corporations – Any amount received as consideration by a transferor S corporation is treated as tax-exempt income and must be separately stated for the purposes of passing through income under section 1366. Each shareholder would take into account its pro rata share of any tax-exempt income resulting from the receipt of cash by a transferor S corporation. The Proposed Regulations clarify that any tax-exempt income resulting from the receipt of cash for the transfer of a specified credit portion by a transferor S corporation is treated as received or accrued, as of the date the transferred specified credit portion is determined with respect to the transferor S corporation. Put differently, any tax-exempt income resulting from the receipt of cash by a transferor S corporation for a transferred specified credit portion should be allocated to the same shareholders and in the same proportionate amount as the specified credit portion would have been allocated if not transferred.

Allocations of a transferred specified credit portion by a transferee S corporation are not a violation of the no second transfer rule. Cash payments by a transferee S corporation are treated as an expenditure because such payments are nondeductible. Each shareholder of a transferee S corporation would take into account its pro rata share of any transferred specified credit portion.

Registration under 6418(g)

Pursuant to Congress’ grant of authority in section 6418(g), Treasury and IRS created registration requirements for credit transfers. The pre-registration requirements identified in the Proposed Regulations are as follows:

• An eligible taxpayer must complete the pre-filing registration process electronically through an electronic portal, which IRS aims to launch before the end of 2023.
• An eligible taxpayer must satisfy the registration requirements and receive a registration number prior to making a transfer election on its return for the taxable year at issue.
• An eligible taxpayer is required to obtain a registration number for each eligible credit property with respect to which it makes a transfer election of a specified credit portion.
• An eligible taxpayer must provide the following information as part of the pre-filing registration process:
  • The eligible taxpayer’s general information, including its name, address, taxpayer identification number, and type of legal entity;
  • Any additional information required by the IRS electronic portal, such as information establishing that the entity is an eligible taxpayer;
  • The taxpayer’s taxable year;
  • The type of annual tax return(s) normally filed by the eligible taxpayer, or that the eligible taxpayer does not normally file an annual tax return with the IRS;
  • The type of eligible credit(s) for which the eligible taxpayer intends to make a transfer election;
  • Each eligible credit property that the eligible taxpayer intends to use to determine a specified credit portion for which the eligible taxpayer intends to make a transfer election, and, for each such property, any further information required by the IRS electronic portal, including:
    • The type of eligible credit property;
    • Physical location (address and coordinates (longitude and latitude) of the eligible credit property);
    • Any supporting documentation relating to the construction or acquisition of the eligible credit property;
    • The beginning of construction date, and the placed in service date of the eligible credit property; and
    • Any other information that the eligible taxpayer believes will help the IRS evaluate the registration request;
  • The name of a contact person for the eligible taxpayer; and
  • Any other information the IRS deems necessary for purposes of preventing duplication, fraud, improper payments, or excessive payments under this section that is provided in guidance.

Special Rules

Excessive Transfer – The Proposed Regulations provide special rules relating to the determination of an “excessive credit transfer,” as well as reasonable cause for a transferee taxpayer.

As a general matter, where Treasury or IRS has identified an excessive credit transfer, section 6418 imposes an additional tax on transferees (regardless of whether the transferee taxpayer would have been subject to tax) equal to the sum of (i) the amount of such excessive credit transfer, plus (ii) 20 percent of such excessive credit transfer. The 20 percent penalty will not be imposed if the transferee taxpayer satisfies the IRS that the excessive credit transfer resulted from reasonable cause.

The Proposed Regulations define “excessive credit transfer” to mean, with respect to an eligible credit property, an amount equal to the excess of: (i) the amount of the specified credit portion claimed by the transferee taxpayer with respect to such eligible credit property for such taxable year; over (ii) the amount of the eligible credit that, without the application of section 6418, would be otherwise allowable under the Code with respect to such eligible credit property for such taxable year. Where a credit is transferred to multiple transferees, all transferee taxpayers are considered one transferee for calculating whether there was an excessive credit transfer and the amount of the excessive credit transfer. A recapture event, described below, does not result in an excessive credit transfer.

The identification of an excessive credit transfer is a facts-and-circumstances determination, and the determination of reasonable cause includes an evaluation of a transferee taxpayer’s efforts to determine that the amount of eligible credit transferred by the eligible taxpayer to the transferee taxpayer 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 has not been transferred to any other taxpayer.

Circumstances that may indicate reasonable cause can include:

• review of the eligible taxpayer’s records with respect to the determination of the eligible credit (including documentation evidencing eligibility for bonus credit amounts);
• reasonable reliance on third party expert reports;
• reasonable reliance on representations from the eligible taxpayer that the total specified credit portion transferred (including portions transferred to other transferee taxpayers when an eligible taxpayer makes multiple transfer elections with respect to a single credit property) does not exceed the total eligible credit determined with respect to the eligible credit property for the taxable year; and
• review of audited financial statements provided to the Securities and Exchange Commission (and underlying information), if applicable.

Recapture – Section 6418 includes a recapture mechanism. If an investment credit property is disposed of (or otherwise ceases to be investment credit property with respect to the eligible taxpayer) before the close of the recapture period (as described in section 50(a)(1)), the eligible taxpayer must provide notice of such occurrence to the transferee taxpayer, and the transferee taxpayer must provide notice of the recapture amount (as defined in section 50(c)(2)), if any, to the eligible taxpayer. The Proposed Regulations provide some requirements as to the contents of such notices, authorizes the IRS to issue further requirements, and permits the parties some latitude to contract for certain further requirements.

The Proposed Regulations include a rule that the recapture amount is calculated and taken into account by the transferee taxpayer.

REIT Issues – The Proposed Regulations address certain issues raised by stakeholders related to real estate investment trusts (REITs). First, some submitted comments requested clarification that eligible credits that have not yet been transferred are treated as a real estate asset, cash, or cash item and thus, will not potentially cause a REIT to fail the section 856(c)(4) asset test. Treasury and IRS refuse to provide such clarification, instead noting simply that the Proposed Regulations, particularly those regarding the paid in cash and timing of sale requirements, will “assist REITs in managing issues with the REIT asset test.” Second, commenters also requested that the proposed regulations clarify that the transfer of an eligible credit pursuant to section 6418 is not considered a dealer sale under the REIT prohibited transactions rules of section 857(b)(6). Treasury and IRS again refused to include such clarification, noting their position that no prohibited transaction tax issue arises from the transfer of eligible credits. The preamble to the Proposed Regulations further notes that becoming entitled to a tax credit generally does not constitute gross income.

Conclusion

The Proposed Regulations provide much-needed guidance and clarification on the new transferability regime, answering a number of questions commonly posed regarding these rules, although not always in a way favorable to taxpayers. Nonetheless, we expect to see rapid development in the market for the transfer of renewable energy credits now that Treasury and IRS have set forth this comprehensive guidance.

[View source.]