Energy sector transformation under the TCJA

October 2018 | FEATURE | CORPORATE TAX

Financier Worldwide Magazine

October 2018 Issue

A major piece of tax legislation and the most significant overhaul of US tax policy since 1986, the Tax Cuts and Jobs Act (TCJA) – signed into law by president Trump in December 2017 – has thus far had a significant impact on individuals, businesses and sectors.

One sector particularly disrupted by the provisions contained in the TCJA is energy – disruption both beneficial and detrimental. “Like other sectors, the energy sector will benefit from the reduced corporate income tax rate, the repealed corporate alternative minimum tax and the greater availability of bonus depreciation,” says Richard Husseini, chair of the tax department at Baker Botts LLP. “Like other sectors, the energy sector will be adversely affected by the new interest deductibility limitation.”

That said, unlike other sectors, the new net operating loss (NOL) limitations will not immediately adversely affect many companies in the sector, because pre-TCJA NOLs accumulated during the recent energy downturn are not subject to these new limitations. “Additionally, because energy companies have significant untaxed earnings outside the US, the TCJA transition tax on untaxed earnings is also likely to impose a significant cost on the sector,” adds Mr Husseini.

Taking advantage

Although it comes with caveats, the TCJA is, generally speaking, proving to be favourable legislation for the energy sector, with energy companies not slow to take advantage of its provisions.

“Projects that have reached the point in their lives that they are generating taxable income are more valuable than they were before because they are now subject to a 21 percent, rather than 35 percent, tax rate,” explains David Burton, a partner at Mayer Brown LLP. “Some owners of interests in older operating projects have sold their interests to capture the resulting higher valuations.”

“Although it comes with caveats, the TCJA is, generally speaking, proving to be favourable legislation for the energy sector, with energy companies not slow to take advantage of its provisions.”

Also proving beneficial is the TJCA’s inclusion of a 100 percent bonus depreciation provision. “Some leasing companies have executed sale-leasebacks on solar projects to monetise the 100 percent bonus depreciation benefit for project sponsors,” says Mr Burton. “The 100 percent bonus depreciation means the benefit that is available is available over a one year period, rather than six years.”

According to Mr Husseini, many companies are asking whether C corporation structures may prove more attractive after the TCJA, as well as analysing whether certain of their non-US subsidiaries should instead become US subsidiaries. “Master limited partnerships (MLPs) and other pass-through entity structures still have their historical advantage after the TCJA because of the pass-through deduction that preserves an effective lower rate of taxation,” he says.

Negative but favourable

In terms of the US renewable energy sector, many commentators feel that the impact of the TCJA has been largely negative. “Renewable energy sponsors are able to raise less tax equity because the corporate rate cut makes the depreciation benefit worth 40 percent less than it was before,” explains Mr Burton. “Furthermore, some tax equity investors with foreign parents or significant foreign operations have had their appetite for energy tax credits substantially reduced. Such tax equity investors are either out of the market or originating tax equity to syndicate it.”

Despite these setbacks, the US renewables sector appears to be thriving overall. “This is because non-tax forces are making up for the damage done by the TCJA,” believes Mr Burton. “There is a huge wave of capital looking to invest in US renewables. That has driven down interest rates and led to more borrower-favourable debt service coverage ratios. This has also allowed sponsors to fill the gap created by being able to raise less tax equity by raising more debt.”

Measure of clarity

In addition to providing a measure of clarity, the TCJA has also introduced new opportunities, as well as challenges, to the energy sector.

“Generally, I do not view the TCJA as making the domestic energy sector more competitive, although it makes it easier for US-headquartered multinationals to compete in foreign markets, whether in energy or other sectors,” says Mr Burton. “Being generally competitive in foreign markets is what the TCJA is really about, rather than an effort to specifically support the domestic energy sector, which no one suggests is its intention.”

More sanguine as to the competitive merits of the TCJA is Derek S. Green, deputy chair of the tax department at Baker Botts LLP. “With the corporate tax rate reductions, greater bonus depreciation and the move to a quasi-territorial regime, the TCJA reduces the competitive disadvantages that US based energy companies had experienced relative to their non-US competitors,” he suggests.

Like most legislation, the TCJA will have its winners and losers. The challenge for the energy sector is to extract maximum benefit from what is a radical US tax reform and ensure it is on the ‘winning’ side.

Fraser Tennant