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When the government provides tax credits or incentives to encourage development of renewable energy projects – such as through the Inflation Reduction Act of 2022 (IRA) – it wants to ensure the credits are being allocated correctly. In the view of the tax equity investor, or tax credit buyer (we’ll simplify and use the term “tax investor”), there are risks that the project will 1) fail to meet the qualification requirements for receiving the incentives, 2) overstate the credits it qualifies for or 3) that the government will change the policies governing these incentives. If this happens, the government may require the tax investor to pay back incentives that were provided (and the sponsor/developer is likely on the hook for this loss as they are typically providing an indemnity to the tax investor). This is known as tax recapture, and it can be a significant financial burden for project developers and tax investors alike. Tax recapture insurance is an important tool to allocate risk away from both project developers and tax credit buyers. It protects against the (hopefully very unlikely!) possibility of the government clawing back tax credits or other incentives that were provided. This can help to reduce the financial risk of developing a project, and can make it easier for project developers to secure the tax credit sales and cash they need to make their projects viable.
What do tax credits qualify for, and how to manage recapture risk?
There are four key areas where the government may claw back a portion or all of the tax credits related to climate infrastructure provisions in the IRA:
Start of Construction Certain provisions – primarily the Wage and Apprenticeship Standards rule – make it important to establish when construction of a project was was started, and when guidance and standards are established by the Treasury Department.
Qualified Basis As was the case prior to the IRA, the same risks (although now with more detail) apply in terms of whether or not the project actually qualifies for the provision and if the fair market value of the project is appropriately calculated. An (unlikely) change in regulation can also impact the qualification of projects.
Structural Tax Risk and Seller’s Financial Wherewithal For traditional tax equity investments, there is structural risk that the partnership or lease structure doesn’t meet the IRS requirements. For transferability, most buyers of tax credits would still require the seller to provide indemnity to cover any recapture due to transferability ownership concerns, but in many cases there may be concerns about the financial strength of the developer’s financials.
Depending on the overall risk of tax credits being claimed, some tax investors may prefer the seller insure the entirety of the tax credits, only the amount being stepped up in fair market value, or the portion of certain adders. Basis’ platform can help buyers and sellers determine what is the right amount of coverage for them.
Bonus Tax Credit Amounts (aka “Adders”) In addition to the Wage and Apprenticeship Standards, which raise the base rate of 6% ITC to 30%, there are a variety of other adders that can add tax credits if:
Depending on the overall risk of tax credits being claimed, some tax investors may prefer the seller insure the entirety of the tax credits, only the amount being stepped up in fair market value, or the portion of certain adders. Basis’ platform can help buyers and sellers determine what is the right amount of coverage for them.
How Basis can help
Because of these various risks associated with tax credit qualification, tax recapture insurance continues to be an important mitigation measure for the climate infrastructure industry. Not only does it protect against the possibility of the government clawing back tax credits or other incentives that were provided to a project, but it also helps both buyers and sellers of tax credits understand the ongoing risk after a tax credit transfer, and how best to allocate it so neither party can get their tax credits clawed back. It is also important to note that this tax recapture insurance is in addition to the typical property and liability insurance that is standard for all projects.
Basis Climate is innovating the tax credit industry by providing project developers and tax credit buyers the option to include their projects in our custom grouped insurance policy. We look forward to helping you determine if insurance is the right fit for your project and tax credit buyer.
