Kirkland tax partner Scott Cockerham spoke with Law360 regarding the Internal Revenue Service’s proposed regulations to its Section 45Q provision.
The economic fallout from the novel coronavirus has the potential to disrupt carbon capture project investments, as actors in the tax equity market that have been hit hard by the pandemic may have little use for tax credits for the foreseeable future.
The tax equity market, in which the rights to tax credits are swapped for equity investments in a company, will be key in determining whether the revamped carbon capture and sequestration tax credit, established under Internal Revenue Code Section 45Q, will be successful.
The Internal Revenue Service's recent proposed regulations on the provision were largely welcomed by industry groups and will likely encourage some investors to move capital into projects. But because many businesses have suffered heavy losses due to the coronavirus pandemic, the generous nature of the tax credit and the IRS' guidance may not be enough to activate capital en masse for the time being.
In short, if banks, financial institutions and other tax equity investors aren't realizing profits, they wouldn't benefit from credits that lower their tax liabilities, and the carbon capture credit may not appeal to them.
"What we're seeing currently is that, except for a couple very big industry players who have preexisting relationships with developers, most of the tax equity investors are hitting pause on committing capital for the time being," Scott Cockerham, tax partner at Kirkland & Ellis LLP, told Law360.
The question of whether investors would benefit from tax credits in the foreseeable future given the underlying market dynamics will likely be key in determining Section 45Q's future success. Some lawmakers and advocacy groups have called for extending the credit's 2024 beginning-of-construction deadline and providing direct cash payments in lieu of the credits.
Section 45Q provides for a tax credit of up to $50 per metric ton of carbon captured in qualified facilities. The credit was revised under the Bipartisan Budget Act of 2018 , allowing companies to claim varying degrees of the credit if they engage in carbon capture and sequestration in association with enhanced oil recovery activities or in other contexts.
Carbon capture and sequestration is a process by which carbon oxides are seized at the point of emission — at power plants, for example — and then permanently stored, or sequestered, deep underground in saline reservoirs or in oil and gas fields. The aim is to reduce atmospheric greenhouse gases that contribute to climate change.
In the recently proposed rules, the IRS definitively prescribed which avenues could be used to demonstrate secure geological storage. The rules also, for the first time, provided details on when the credit could be recaptured.
The agency proposed a five-year recapture period, which is in line with credits for renewable energy projects such as those in wind and solar energy, which will be helpful for activating the tax equity market, Cockerham said.
Even so, the proposed regulations would likely encourage more market activity if it weren't for the coronavirus pandemic and its economic fallout, said Sam Kamyans, a partner at Akin Gump Strauss Hauer & Feld LLP.
"At least one major tax equity investor has said the proposed regulations make the credit a bankable credit, but that the current pandemic is a major impediment to financing," he said.
That's an analysis shared by Brad Crabtree, vice president of carbon management for the Great Plains Institute and director of the Carbon Capture Coalition. He told Law360 that the regulations themselves would have likely been enough to move significant capital off the sidelines if the IRS had released them before the pandemic had begun to rock the carbon capture industry.
"With the COVID-19 pandemic, companies are facing existential challenges to their businesses," he said. "They're naturally slowing down and even putting on hold work on some of these projects as they deal with the losses of markets, supply chain and workforce issues," he said.
In response, Congress should extend the beginning-of-construction deadline for the Section 45Q credit, which is currently set for 2024, Crabtree said. Last month, seven senators sent a letter to Treasury Secretary Steven Mnuchin asking him to institute a one-year extension of the commence-construction deadline in light of the pandemic and the fact that the IRS had not yet released final guidance on the credit.
Congress should also allow direct cash payments in lieu of the credits in order to appeal to the tax equity market, Crabtree said. Lawmakers have made such a move before. In the wake of the 2008 recession, Congress passed the American Recovery and Reinvestment Act , which permitted the Treasury Department to dole out grants for energy projects to replace renewable energy production and investment tax credits under Internal Revenue Code Sections 45 and 48 .
While those measures could prove helpful, the underlying dynamics of the tax equity market will eventually prove decisive, Cockerham said. Whether capital moves into the projects "has to do with what [investors'] tax liability is going to look like this year," he said, which at the moment, is nearly impossible to forecast.
He added: "Do they really need credits?"