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The Future of Tax Equity in Solar
Written By: Jen Neville
March 15, 2017
Jonathan Silver, Managing Partner, Tax Equity Advisors
Jonathan Silver is one of the nation’s leading clean energy investors and advisors. One of the country’s “Top 10 Green Tech Influencers”, he led the federal government’s $40 billion clean energy investment fund, the largest fund of its kind in the world. He also led a $20 billion fund focused on electric vehicles. He regularly advises some of the largest institutional investors and companies in the sector. Earlier, he co-founded Core Capital Partners, a leading venture capital firm and was the COO of Tiger Management, one of the country’s largest and most successful hedge funds. He began his career at McKinsey & Company, the global management consulting firm. Mr. Silver’s government service includes stints as senior policy advisor to the U.S. Secretaries of Commerce, Energy, Interior, and Treasury. He is, or has been, on the boards of numerous organizations, including: the Wind Energy Foundation, American Forests and the Solar Electric Light Fund. He is a former Adjunct Professor at Georgetown University’s McDonough School of Business. Mr. Silver is a graduate of Harvard University, received a CEP from the Institute of Politics in Paris and did doctoral coursework at the Graduate Institute of International Studies at the University of Geneva. He has received both Fulbright and Rotary Graduate fellowships.
THE FUTURE OF TAX EQUITY IN SOLAR
Stratton Report: Given the current market uncertainty, what does tax reform mean for Solar in terms of the impact of a lower tax rate and how tax equity investors and sponsors are approaching financing projects?
Jonathan Silver: Good question. First, I think it’s important to note that it’s not yet clear that tax reform will actually happen. I’m drawing a distinction there between real tax reform and tax cuts. The jury is still out on whether or not there will be any kind of significant or comprehensive tax reform and I would not be surprised if the end result is a simple discussion about future tax rates. However, even simple tax cuts can have a significant impact on this market. A tax cut could certainly affect some deal economics. It could mean that there’s less tax equity available. In some scenarios, if tax rates go down, there could be less capital for investment. Of course, depreciation might shrink as well.
It’s important to remember that a dollar of tax credit is a dollar of tax credit. So that even if tax rates were to drop, the value of a tax credit dollar would still be equal to, or as useful as it was, before. Tax cuts might take some of the attention off the advantages of a tax credit dollar but it wouldn’t take them away.
The second thing that’s probably worth pointing out is that even though the top marginal corporate tax rate is 35%, in reality, the top rate that most corporations pay is 25%, 26%, 27%. So dropping the top marginal rate from 35 to some place in the mid-high 20s, would not actually necessarily drive significant tax cut dollars back to the private sector.
SR: If there is tax reform, I know that you’re saying it’s still questionable at this point. But what do you see as the biggest opportunity and/or challenge for the renewables markets that will be created by tax reform?
JS: I don’t know that the tax reform per se creates specific new opportunities for tax equity. It depends entirely on what those reforms would be. If you’re asking in general what the opportunities in the sector are, I think they’re significant. And despite the confusion around and consternation around what the results of the tax discussion will be, the solar industry continues to grow significantly year over year. The industry continues to drive costs down. At some point it is inevitable that the cost of solar, and the cost of renewables in general, will always be less than the cost of fossil because most renewable inputs are free. Eventually, there’s really nothing to stop the United States and the world from moving much more aggressively to greater use of renewables.
But the biggest change doesn’t have anything to do with tax at all. The biggest change I think is that public perception has moved markedly towards support for increased use of renewables. A majority of Americans now think that it’s beneficial to use renewable power. And that number continues to grow.
SR: Moving on to the current tax equity market, which are the most active types of investors in the tax equity market and what sectors are they participating in?
JS: It depends on what you mean by most active; number of deals done, dollars deployed, et cetera. I would say that, in general, banks and insurance companies remain the largest tax equity investors. However, there’s been a dramatic increase in the number of corporates interested in, and investing in this space and investing at scale. Tax Equity Advisors’ entire business revolves around managing solar investments for large corporations with significant tax that want to move into the space. And we’re seeing a lot of interest in that. The big corporations like the GEs of the world have done tax equity investing for many years but, in the last couple of years you’ve seen companies like Intel, Liberty Media, Patagonia, Lowe’s, Publixes and others begin to invest in tax equity as well. And I think you’re going to see corporates continue to increase their presence in the space.
SR: What are the most common deal structures in the market today in terms of obstacles in deal structures and how they’re being addressed?
JS: Assuming we’re talking about solar, the partnership flip structure remains the largest and most frequently used structure. There are several others like sale leasebacks that people certainly use on a regular basis. But I think the market has generally moved towards the partnership flip structure as the most common mechanism for making these investments.
SR: And then what are the current obstacles in deal structures and how are they being addressed?
JS: I don’t know that I’d call them obstacles but there are certainly large numbers of deal points that need to be negotiated in every transaction. That actually raises a somewhat different issue which is, it possible in fact to standardize these agreements. It has been a bit elusive although a lot of credit goes to SEIA and other entities that are working on standardizing various kinds of documents, like the tax equity investments, PPAs and others.
One of the newest deal points concerns future tax rates, and here the question is, what do you do in an investment if the tax rate changes going forward and perhaps retroactively as well? Tax rates are almost never imposed retroactively, but it’s theoretically possible. So documents now include language around the scenario planning for a potential change in tax rates.
SR: Okay. And moving a little bit back towards the financing and tax equity market, how do you think we can bring greater efficiency to tax equity financing?
JS: Well, it would be attractive to find ways to make this process more efficient. The challenge is that every deal, every transaction is different. There are different permitting issues, location issues, different EPC related issues or O&M issues, different financing and indemnification issues in every transaction. On the other hand, work is taking place to try to standardize parts of this and that’s to be commended. But my view is that it remains difficult to drive efficiency into the documentation process around these transactions.
SR: Okay, We did speak a little bit earlier also about the move towards corporate partnerships. But talking about the types of deal structures, what are tax equity investors’ views on outside corporate PPAs, community solar projects and CCA structures?
JS: Those aren’t directly connected. Corporate PPAs and corporate interest in community solar are two somewhat different things. I would say that there’s a substantial interest in both. They’re just different. More companies than ever are looking at and beginning to write off-take agreements. Separately, there’s increasing interest in investing in community solar projects. I would say that there are probably more companies that have more experience with corporate PPAs than they do with investing in community solar.
SR: In terms of the ITC, approximately 3 years are left with the ITC at 30% and then we’re going to move down into 10% by 2023. What can the industry get done in this time period and what are the greatest challenges or opportunities that might be there?
JS: Well, the industry can get a lot done. The solar pipeline is measured in gigawatts. There must be 15, 20 gigawatts of short – to medium-term pipeline out there. So as long as there is a sense that there will be no future changes to whatever the result of the tax reform discussion is, I think you could see substantial amounts of capital come in to the sector.
SR: What are the biggest challenges and opportunities that are still missing or that can still be taken advantage of over the next few years of the ITC?
JS: I think everybody understands that the ITC is beginning to sunset in the early ‘20s. That of course has increased interest in doing things now. That increased interest is mildly offset or mitigated by the uncertainty around the environment in which those investments would be made. But once we have some clarity on that, I think you’re going see a substantial wave of investment capital come in to this sector. More capital comes in, more deals will get done. But it will also drive returns down to a place where the risk reward profile certainly from a developer’s perspective maybe more in line with the opportunity itself.
SR: Okay. So you are you saying the risk gets lower as we move towards the lower ITC or is the risk is increasing?
JS: No, the risks don’t get lower as we reduce the ITC, the additional capital coming in to the space drives down the returns, and perhaps from a developer’s perspective, that may better reflect the risk reward profile of the transactions themselves as they perceive them.. But I think that without clarity around what tax rate is going forward will be, we will only continue to move forward in fits and starts.
SR: Right, yes, clarity is going be the most important issue going forward.
JS: Yes. You know, it’s interesting. My sense is that it almost doesn’t matter what the final tax rate is as long as there’s a number. It matters more that there is a number rather than what that number actually is.
SR: Before we conclude, is there anything that I haven’t given you the opportunity to share that you think is important for our audience?
JS: Thanks for your questions. I guess I would only add that tax equity is a really attractive investment vehicle for corporations with significant tax liabilities. In general, it lowers their effective tax rate and often produces a bump in earning per share. The transactions are structured to generate a cash return. And there are very few investments which provide all of those things to a corporation given the capital that they’re using for these investments which essentially are their tax liabilities. My view is that once the dust settles on what the Federal tax regime looks like, we will see companies begin to focus more strongly on this investment vehicle and I think you’re going to see a significant wave of capital come in to the space as a result. And I think that bodes well for the Solar industry.