The election of President Trump introduced uncertainty relative to renewable energy in the United States. The recently enacted Tax Cuts and Jobs Act (TCJA or tax reform) has provided some clarity for the sector, and its provisions have introduced new opportunities for renewable energy as well as some new challenges.
Let’s explore the various provisions included in the TCJA and its impact on U.S.-based manufacturers of renewable energy equipment and renewable energy production facilities. Following is a summation, albeit non-comprehensive, of provisions of the TCJA that could have meaningful impacts on various sector stakeholders:
- Corporate tax rate reduction — The federal corporate tax rate has been reduced from 35 percent to 21 percent.
- New transition tax — A transition tax will be imposed on untaxed foreign earnings of foreign subsidiaries of U.S. companies by deeming those earnings to be repatriated. Foreign earnings held in the form of cash and cash equivalents are taxed at a 15.5 percent rate, and the remaining earnings are taxed at an 8 percent rate.
- Section 199 repeal — Section 199 allowed a taxpayer to claim a deduction for qualified production activities; this deduction has been repealed for tax years beginning after Dec. 31, 2017.
- Immediate expensing — Bonus depreciation has been increased from 50 percent to 100 percent for “qualified property” acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2023.
- Base erosion anti-abuse tax (BEAT) — The BEAT is a tax intended to penalize payments made by multinational companies to foreign parent entities from U.S. subsidiaries.
The reduced corporate tax rate, as well as the opportunity to immediately expense newly acquired assets, is likely to provide an immediate cash-tax benefit, allowing for manufacturing operations in the U.S. to be more profitable. The repeal of Section 199 may have a negative, although limited, impact to manufacturers. This impact may be offset by the benefits provided by the lower tax rates and immediate expensing provisions. The transition tax introduces an immediate burden on those U.S.-based manufacturers that are holding earnings in foreign subsidiaries, but provides them an ability to bring back cash with a significantly lower tax burden than under the previous statute.
Overall, it is anticipated that the new regime could create and nurture the renewable energy supply chain in the U.S. Manufacturers may have the opportunity to retain more cash to invest in equipment and workers. Siting manufacturing operations in the U.S. could provide renewable energy manufacturers the opportunity to directly serve the growing renewable electricity generation market. In addition, establishing a U.S. presence may help to avoid newly instituted tariffs on solar equipment imports.
Renewable energy equipment manufacturers do not exist in isolation. The future demand for renewable energy will be driven by a number of policy and technological considerations. On the policy side, renewable energy adoption could be bolstered by the preservation of the Clean Power Plan, the implementation of a national renewable portfolio standard or a carbon trading regime, or the extension of the Investment Tax Credit (ITC) and/or the Production Tax Credit (PTC).
On the technology side, incremental improvements in solar panel and wind turbine technology are expected to increase power density and generation metrics; however, the largest technology variable to consider is arguably the advancement of storage technology. Taking these factors into consideration, the National Renewable Energy Laboratory (NREL) predicts in its average case projections that in 2030 renewable energy is expected to constitute 26 percent of the overall U.S. electricity generation portfolio, up from 15 percent in 2016. This anticipated ever-increasing demand for renewable energy suggests an ongoing need for new renewable energy equipment to be manufactured.
Implications for Renewable Energy Production Facilities
In order to gauge the potential impact of the TCJA across the renewable energy supply chain, we must also consider renewable energy production facilities. It is expected that certain existing renewable energy production facilities (i.e., those near the end of their accelerated depreciation schedule) immediately became more valuable when tax rates fell to 21 percent, as the expected taxable income from those projects will be taxed at a lower rate.
The reduced corporate tax rate, as well as the opportunity to immediately expense newly acquired assets, is likely to provide an immediate cash-tax benefit, allowing for manufacturing operations in the U.S. to be more profitable. However, financing these facilities may become more challenging. A major component of renewable energy production facility finance in the U.S. comes in the form of so-called tax equity. Tax equity is a financing mechanism whereby an investor contributes capital to a renewable energy production facility in exchange for a special allocation of the tax incentives that project generates. In recent years, the supply of tax equity has been steadily increasing, resulting in a shrinking cost of capital for developers and making these developments more attractive. However, it is expected that a combination of the lower corporate tax rate and the BEAT will restrict the supply of tax equity, increasing the cost of capital to developers. This will undoubtedly create a headwind that will partially offset the increased value of the lower tax bill the project will generate over its life. Increased yield requirements will place pressure on project developers to optimize other aspects of their capital structures in order to achieve the types of returns to which they have become accustomed.
Exacerbating this pressure on capital cost are the solar trade tariffs mentioned above. Whether equipment is manufactured in the U.S. to avoid tariffs, or equipment is purchased from overseas and burdened with the tariffs, the outcome is that renewable energy project developers will have increased installed costs, making it more difficult to achieve historical or desired returns on new installations.
The TCJA has changed a number of key aspects of investing in the U.S. at both the federal and state levels. The complexity and interdependent implications of the changes are just beginning to be understood by professionals and industry stakeholders. The clear intention of the TCJA has been to make the U.S. more business-friendly. The degree to which that intention will be realized is dependent on a number of factors that will become clarified as time passes and industry stakeholders react.
What does all of this mean for U.S. manufacturers, foreign companies with U.S. manufacturing operations, and those foreign companies that — in light of tax and tariff reform — may be considering entering into the U.S.? Companies must now re-evaluate how they think about their strategic growth projects. Companies should be prepared to take a fresh look at all planned capital expenditures given a lower overall U.S. tax rate.
The transition tax introduces an immediate burden on those U.S.-based manufacturers that are holding earnings in foreign subsidiaries, but provides them an ability to bring back cash with a significantly lower tax burden than under the previous statute. Additionally, potential repatriation could help domestic entities fund previously “mothballed” projects. A business planning refresh will require coordination between stakeholders within an organization, including operations, supply chain, real estate, legal, human resources, and tax. These stakeholders will need to not only identify, through a thorough site selection search, the optimal location for investment, but also identify the availability of state and local tax credits and incentives and the upfront and operational cost offsets that would enhance the ROI of the proposed manufacturing project.
What does all this mean for renewable energy production facilities? Renewable energy production facility developers must reconsider how to optimize their capital structures in this new environment. Various factors such as BEAT and immediate expensing are likely to increase the scarcity of tax equity, making it a relatively more expensive financing tool than it has been in recent history. On the other hand, the lower 21 percent tax rate will increase the after-tax cash flows from the production and sale of electricity, making certain facilities more valuable. As more facilities are financed and placed into service, the optimal interplay of these provisions will become more apparent.
On the whole, the clarity provided by the passage of these new tax laws has removed a great deal of uncertainty. Renewable energy is a relatively young industry that has seen more than its fair share of change and upheaval. With the passage of the TCJA, industry stakeholders must once again rise to the occasion by adapting their business practices and finding new ways to optimize their growth strategies.
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