Historical and New Energy Credits Indicate “Potential” New Tax Strategy
Historically, the Code provided two types of credits for renewable energy projects. The first being the production tax credit (PTC) and the other being the investment tax credit (ITC)—both of which fell under the scope of the general business credit of § 38.
These two credits were set to expire in 2021 and 2023. Moreover, the credits covered a limited set of production and investment activities. The Inflation Reduction Act (i) extended the time frame for which the credits are available to taxpayers, and (ii) expanded the activities covered. Understandably, this expansive legislation precipitated the promulgation of some lengthy Treasury Regulations. In that process, the Treasury received comment on “chaining” certain business credits.[1]
To understand the term “chaining”, there are two relevant Internal Revenue Code (Code) provisions that taxpayers are seeking to chain together which serve as the basis for the analysis.
Chaining
To start, under § 6418(a), eligible taxpayers may elect to transfer certain credits to unrelated taxpayers rather than apply the credit against its income tax liability. This process allows a taxpayer to finance its operations and current liabilities with a tax credit that provides no current value to it. Often times, the qualifying taxpayer is a nascent business in an emerging market. Having this newly furnished tax asset provides capital without taking on debt or issuing new shares.
Therefore, if a transferee-taxpayer (the purchaser) would receive a current benefit from an income tax credit, then transferor-taxpayer (seller) may sell the credit at a discount. In sum, this forms the first link in the chain—transfer of the credit.
The next step is for the transferee-taxpayer to utilize another tax credit monetization provision in the Code. Pursuant to § 6417(a), an applicable entity may elect to treat an applicable credit as a payment against income tax. Thus, chaining becomes the process of taking a recently purchased income tax credit and subsequently making an election to treat it as a payment against an income tax liability.
At first glance, this does seem to implicate formerly abusive transactions which Congress sought to address under § 7701(o).[2]
Treasury Interpretation & Request for Comment
In response to comments, the Treasury proposed regulations for § 6417 that were finalized in March of 2024.[3] The Treasury takes the position that when §§ 6417 and 6418 are read together, they are “most straightforwardly understood as creating two separate, mutually exclusive regimes regarding credit monetization.” Notably, however, the Treasury does recognize that, “no specific language in §§ 6417 and 6418 directly prohibits chaining”. Rather, in order to have a “straightforward application” of the statute as a whole, the Treasury posits that it is best to not permit chaining.
However, the Treasury has not closed the door entirely. It has requested comment to address the issue.[4] In doing so, the Treasury highlighted that its argument is primarily textualist in nature. The Treasury stated,
“This view is based, in part, on the text ‘determined with respect to’ in both statutes, which is more straightforwardly interpreted as requiring an applicable entity to own the underlying applicable credit property and conduct the activities for which the applicable credit is ‘determined with respect to[.]’”[5]
The Treasury appears to be somewhat reticent to outright deny the process of chaining and is making a good faith effort to receive input from stakeholders. In asking for comment, the Treasury specifically noted that it would welcome comments that demonstrate the impact chaining, if allowed, would have on the credit transfer market with regard to (i) the general impact, (ii) demand and market participation rate, and (iii) the effect on pricing transferred credits. Generally speaking, answering such prospective questions may prove impossible. However, influencing behavior with favorable tax laws is the very basis for promulgating such sweeping energy credit legislation in the first place. Large investments in renewable sources of energy could have an exponential impact on our society.
For taxpayer motivation, it could be that many taxpayers are seeking to make an election to treat the credit as a payment against income tax for certain cost savings with respect to the time-value of money. Otherwise, how feasible would it be to pay for a credit that produces a benefit in the filing year. The savings of the discounted purchase may end up being washed out. Alternatively, it may be that chaining produces a favorable E&P outcome for C-corporations.
The Treasury further asked for comment on its textual interpretation of the Code. Noting that, it would like an answer to how a credit being determined with respect to an applicable entity or transferor-taxpayer may reasonably be interpreted to include a taxpayer that does not own the underlying property giving rise to the credit. One might reasonably answer through the purchase and sale of the credit. Presumably, the Treasury is requiring a more legally circumspect answer.
For instance, the credit under § 6418(a) is determined with respect to the eligible taxpayer that elects to transfer to the transferee-taxpayer. Thus, as the Code provides, the transferee-taxpayer “shall be treated as the taxpayer for purposes of this title with respect to such credit (or such portion thereof).”[6]
Accordingly, as we often must do in tax law, we take the exception to the general rule and supplant its language into the general rule.[7] As a result, the transferee-taxpayer (purchaser) has taken the place of the transferor-taxpayer (seller). Importantly, the Code accords this treatment for “purposes of this title” i.e., Title 26 of the U.S.C.[8]
More textual authority may still be gleaned from the Code. Another common occurrence in the Code is to define things in the negative and § 6418 is no exception.[9] An eligible taxpayer under § 6418(a) means any taxpayer which is not described in § 6417(d)(1)(A).[10] Therefore, the transferor-taxpayer (the seller) is the eligible taxpayer—not the transferee-taxpayer (the purchaser). Thus, under that logic, the opportunity for fraud which concerns the Treasury is bottlenecked under the limitation as to what constitutes an “applicable entity” under § 6417.
To that end, the Code rather narrowly defines the appropriate entities under the scope of “applicable entities”.[11] As the Treasury contemplates some form of digital fiat currency, the basis for that relies upon blockchain technology—a verifiable ledger certified by parties with unaligned interests—this may be fertile ground for application of blockchain to help with the administrative concerns that accompany the request for comment.
[1] Prop. Treas. Reg. § 1.6417, 88 FR 40528 (June 21, 2023).
[2] For a general discussion on § 7701(o), see Orly Mazur, Tax Abuse – Lessons from Abroad, 65 SMU Law Review 551 (2012).
[3] Treas. Reg. § 1.6417 (Added by T.D. 9988, 89 FR 17596, March 11, 2024).
[4] Notice 2024-27
[5] Id.
[6] § 6418(a).
[7] Some refer to this style as “Chutes and Ladders”.
[8] Commonly referred to as the Internal Revenue Code.
[9] See, § 1221(a)(1)-(8) defining capital asset as “property held by the taxpayer” except for eight enumerated items.
[10] § 6418(f)(2).
[11] § 6417(d)(1)(A)-(E).
