Proposed Investment Tax Credit Regs Receive Wide-Ranging Comments
The proposed energy investment tax credit regulations (REG-132569-17) had an “everything but the kitchen sink” flavor to them, so they generated hundreds of comment letters on many and varied issues. Now that the deadline for comments has passed, here’s an overview of what changes commentators hope to see in the final regulations.
Biogas Looking for an Upgrade
Section 48(c)(7)(A) defines qualified biogas property as property containing a system that converts biomass into a gas that is not less than 52 percent methane by volume or is concentrated by the system into a gas that is not less than 52 percent methane. In both cases, the property must capture gas for sale or productive use. Subsection (B) includes property that is “part of such system which cleans or conditions such gas.” Letters submitted in response to Notice 2022-49, 2022-43 IRB 321, asked for gas-upgrading equipment, which is necessary for conditioning gas into the appropriate mixture for pipeline injection, to be included in the definition of qualified biogas property.
Under the proposed regulations, an energy property is defined as a unit of energy property if it meets the requirements of prop. reg. section 1.48-9(c) and is a type of energy property included in subsection (e), which includes qualified biogas property. Prop. reg. section 1.48-9(f)(2) adds a functional interdependence test in defining a unit of energy property. Accordingly, components of property are qualified biogas property if they are functionally interdependent. That means that placing each component in service depends on the placing in service of each of the other components in order to perform the intended function of the qualified biogas property.
The nonexclusive examples given in prop. reg. section 1.48-9(e)(11)(i) of functionally interdependent components of qualified biogas property include a waste feedstock collection system, a landfill gas collection system, mixing or pumping equipment, and an anaerobic digester. The preamble explains that this approach is “a technology-neutral way to determine what is considered included in a qualified biogas property and is broad enough to encompass technological changes.”
Treasury and the IRS explained in the preamble that upgrading equipment “is not functionally interdependent with the qualified biogas property that converts biomass into a gas containing not less than 52 percent methane and captures such gas for sale or productive use as specified in the statute,” and thus is not necessary to satisfy the statutory requirements. Because upgrading equipment is only necessary for injection into the pipeline, it’s distinguishable from cleaning and conditioning equipment, which is part of the necessary process to convert biomass into gas that meets the statutory requirements.
In the preamble, Treasury and the IRS asked for comment letters on what components to include within the definition of cleaning and conditioning property. They got them.
Commentators disagreed with the proposed regulations’ approach. The Coalition for Renewable Natural GasGAS led the charge to convince Treasury and the IRS to include gas-upgrading equipment in qualified biogas property as “cleaning and conditioning property.” The coalition also asked for clarification that the point at which the methane content of gas should be measured is when the gas is ready for sale or applicable productive use — in other words, at the end of the cleaning and conditioning process.
Archer-Daniels-Midland also asked the government to remove the blanket exclusion of “upgrading” equipment. “While so called ‘conditioning’ and so called ‘upgrading’ may be referred to as separate phases with different non-technical names, each is designed to ‘clean’ raw biogas or rid it from impurities so that it meets technical conditions for sale or productive use,” the company wrote. The letter explained that conditioning typically refers to the removal of hydrogen sulfide, siloxanes, and other impurities, while upgrading may include removing carbon dioxide, water vapor, and volatile organic compounds.
The U.S. Chamber of Commerce echoed the request to expand the definition of qualified biogas property to include upgrading equipment. “Neither the statute nor its legislative history contemplates any limitation on what constitutes ‘cleans or conditions’ gas for purposes of defining ‘qualified biogas property,’” it wrote. The exclusion of “gas upgrading equipment” makes investments by solid waste businesses and farms in biogas processing infrastructure less likely because they would not qualify for the section 48 credit, the Chamber explained, adding that the investments “help provide communities with additional sources of revenue while reducing emissions and creating a domestic energy source.”
Members of Congress have weighed in on multiple aspects of the Inflation Reduction Act implementation, and four Pennsylvania Republicans, led by Rep. Glenn Thompson, wrote that “the proposed rule misinterprets the original purpose of the ITC, which is to incentivize capital expenditures on property that is used to produce sustainable or renewable energy.” By excluding the “interdependent and integral equipment necessary for cleaning and conditioning biogas into RNG [renewable natural gas]
from receiving the section 48 ITC,” the proposed rules negate congressional intent, they wrote.
Geothermal Industry Cool on Proposed Rules
The geothermal heat pump industry explained that networked geothermal heat pump systems typically have multiple owners, which clashes with the proposed regs because they don’t allow separate ownership of different components of a geothermal heat pump system that are functionally interdependent. “The proposed rule would prevent the separate ownership of ground loops and heat pumps and, as a result, would jeopardize GHP [geothermal heat pump] projects that are currently underway and inhibit investment in future projects,” explained the Geothermal Exchange Organization. It pointed to the Tax Court’s decision in Cooper v. Commissioner, 88 T.C. 84 (1987), which allowed taxpayers to take the section 48 ITC on the portion of the system that they owned, as precedent that the proposed regulations overlook. The organization said there isn’t an obvious policy reason to allow two unrelated taxpayers that each own 50 percent fractional interests of each of the components of a geothermal heat pump unit of energy property to claim the ITC but disallow the claim of those taxpayers if they each owned 100 percent of half of the components of the unit of energy property.
The 80/20 rule doesn’t work for networked geothermal systems either, according to many comment letters. Multiple commentators pointed out that the proposed 80/20 rule on replacement equipment — which applies to the entire project, rather than to each component separately — inhibits the additive expansion that is planned into geothermal networks. The systems are designed to grow by adding customer buildings and ground loop capacity as needed. The Geothermal Exchange Organization noted that ITC-eligible equipment that needs to be replaced won’t meet the 80/20 test because of the definition of a unit of energy property.
The push to change the rules came from political quarters too, a fairly common occurrence in the IRA rulemaking process. Sen. Michael F. Bennet, D-Colo., was joined by Sen. Bernie Sanders, I-Vt., and 13 other Democratic senators in a letter to Treasury Secretary Janet Yellen requesting “guidance clarifying that geothermal heat pump systems are exempt from the ‘limited use property’ doctrine.”
Interconnection Costs
The pre-guidance notices that the IRS and Treasury issued in October 2022 were meant to give the government a head start on identifying issues that needed to be resolved in implementing the IRA, and the experiment appears to have been fairly successful. But not all the issues raised in the pre-guidance comment letters were addressed in the proposed regulations. The government wasn’t required to respond to comments on the original set of notices in the preambles to the proposed rules, so commentators don’t have an explanation for why particular issues were not addressed. One of those issues is how the interconnection rule’s requirement that the “energy property shall include amounts paid or incurred by the taxpayer for qualified interconnection property” operates when one taxpayer pays the interconnection costs but a purchaser of the project claims the ITC.
Two common types of transactions used to monetize tax credits — three-month sale-leasebacks and lease-passthrough transactions — may not qualify for the ITC on interconnection costs for small projects under a strict reading of the proposed regs, because the taxpayer that claims the ITC is not the same taxpayer that paid the interconnection costs, said Andy Fishburn of the Equipment Leasing and Financing Association. A rule that results in owner-operators being treated differently from owner-lessors doesn’t advance the purpose of encouraging the acquisition of ITC property, he said.
The Equipment Leasing and Finance Association suggested in a comment letter that the final regulations add language to prop. reg. section 1.48-12(g)(2) that expands the original use to both include the definition in prop. reg. section 1.48-9(b)(3) and take into account the principles of section 50(d)(4), with the original use determined on the date of the sale-leaseback or lease. Similarly, the definition of interconnection agreement in prop. reg. section 1.48-14(g)(4) should include an acknowledgement that energy property can be leased if there is an election under section 50(d)(5), the organization wrote. The lessee should also be deemed to have incurred the interconnection costs if there is a section 50(d)(5) election, the letter continued. If the government agrees, the IRS will likely want the buyer and seller to identify a portion of the purchase price of the project as reimbursement for the seller’s interconnection costs, which shouldn’t be difficult to do, said David Burton of Norton Rose Fulbright US LLP. The rules might also require that the buyer’s ITC for the interconnection costs be the same as the amount the seller paid.
‘Unit of Energy Property’ and ‘Energy Project’
Commentators sought changes to the definitions of unit of energy property under prop. reg. section 1.48-9(f)(2)–(3) and energy project under prop. reg. section 1.48-13(d). Comment letters pointed out that the energy project framework in the proposed regulations could diminish the use of the domestic content bonus credit, resulting in an increase in the use of foreign products.
The Solar Energy Industries Association (SEIA) asked the government to confirm that power conditioning equipment, including transformers, is an integral part of energy property and is not considered a component of a unit of energy property. In addition, the association asked for clarification that gen-tie lines are considered an integral part of energy property and that the definition of power conditioning equipment be expanded to include software that optimizes or automates the function of the equipment. The final rules should also clarify that a battery that can operate on its own is a unit of energy property, the association said.
The SEIA also asked that the definition of energy project retain the facts and circumstances approach to determining separate energy properties rather than the bright-line rule in the proposed regulations. “The factors at proposed section 1.48-13(d)(1) diverge from existing IRS guidance by abandoning the flexible facts and circumstances approach in IRS Notice 2018-59, which was recently reaffirmed in final rules promulgated under Section 48(e), as added by the IRA,” the association wrote. As an alternative, the SEIA proposed adding a rebuttable presumption to the definition of energy property so that taxpayers could treat portions of an energy project as a single energy property “if multiple technologies, taxpayers, tax years, or interconnection agreements are implicated.” This approach would balance the new rule’s apparent purpose of reducing abuse with the realities of project development, the SEIA wrote.
Similarly, First Solar asked for prop. reg. section 1.48-13(d) to be withdrawn for purposes of the domestic content bonus credit requirements, or for the IRS and Treasury to clarify that the single project rule only applies to energy property in the same category of energy property under section 48. The comment letter explained that proposed regulations compound the problems with the initial domestic content guidance “by aggregating different classes or categories of energy property into a single energy project for domestic content purposes — indeed, in a manner that is inconsistent with the safe harbor categorization of property under Notice 2023-38.” If the single project rule is retained, First Solar asked for the final rules to include confirmation in the text of the regulations that section 45 qualified facilities that are co-located with section 48 energy property are not considered part of an energy project, unless they elect under section 48(a)(5) to be treated as energy property. Confirmation of that treatment was found only in the preamble to the proposed regulations.
RWE Clean Energy LLC asked that the new framework for energy projects in prop. reg. section 1.48-13(d) be made an optional safe harbor method, or that the requirements that must be satisfied for energy properties to be treated as a single project be increased. “The criteria could be modified to require three or four of the seven stated factors to be present instead of just two, or add extra criteria such as time-based parameters,” RWE suggested. The letter also noted that the proposed rules do not address how the new definition interacts with the continuous construction requirements, which should be clarified.
The comment letters set the stage for the February 20 hearing on the proposed regulations. Given the large volume and breadth of the comments, revising the rules and drafting a responsive preamble might take the IRS and Treasury a while.
