Investment in new power generation in North America is expected to be $1.4 trillion cumulatively through 2033, with utility-scale solar, distributed solar, and onshore wind generation being the leading expected investments according to Wood Mackenzie’s 2024 North America Power Markets Strategic Planning Outlook. With the ever-increasing demand for capacity in the power grids, it is anticipated that more investors, including new types of investors enabled by alternative monetization methods for tax credits under the Inflation Reduction Act, will participate in tax equity structures to acquire tax benefits.  Sponsoring investors should be aware of common pitfalls and key considerations around the buyout of tax equity investor’s interest in the partnership and the accounting for the buyout when the partnership winds down.

Tax equity buyout overview

A common tax equity structure is the flip-based partnership. Third-party tax equity investors invest in tax equity structures to obtain and utilize the tax benefits (typically, tax credits and tax losses) that the sponsoring investors are typically not able to realize. After the tax benefits are utilized and the tax equity investor realizes their rate of return (or a specified date is reached), there is a call option under which the sponsoring investor has a right to purchase the tax equity investor’s interest in the partnership. The partnership may also grant a put right to the tax equity investor such that it can require the sponsoring investor to purchase its interest. Upon the occurrence of a buyout of a tax equity investor’s interest in the partnership, there are certain accounting implications that must be considered by the sponsoring investor and the tax equity partnership. 

ASC 810-10: An overview

Commonly, the sponsoring investor has a controlling financial interest in the partnership, and, as such, the sponsoring member consolidates the partnership. However, the facts and circumstances surrounding which investor has a controlling financial interest should be carefully evaluated in each instance. Under ASC 810-10, Consolidation, it must be determined which investor has a controlling financial interest before and after the buyout. If the sponsoring investor reaches the conclusion that it has a controlling financial interest in the partnership before and after the buyout, the buyout is considered an equity transaction among owners. Based on ASC 810-10-45-23, this type of transaction does not give rise to any gain or loss. Any difference between the fair value of the consideration received or paid and the amount required to reduce the noncontrolling interest to zero is required to be recognized in equity attributable to the sponsoring investor, according to ASC 810-10. 

Practical considerations

The sponsoring investor must properly account for the tax equity investor member’s noncontrolling interest through the buyout. Hypothetical liquidation at book value (HLBV) is typically used for GAAP reporting purposes to determine both the allocation of the partnerships’ earnings or losses to the noncontrolling interest holder and the carrying amount of the noncontrolling interest based on the change in the tax equity investor’s claim on the net assets of the partnership using the liquidation provisions of the partnership. This HLBV calculation of the noncontrolling interest carrying value must be accurately calculated before the noncontrolling interest is adjusted to $0 from the buyout. There are certain key factors that should be contemplated before and after the buyout:

1) Buyout date: Buyouts generally do not occur on a year-end date or otherwise clean cutoff date. A stub-period financial close process on the date of the buyout is needed to appropriately determine the value of the noncontrolling interest. The stub-period financial close process should ensure all accruals are appropriately made as of the buyout date. The net assets of the partnership as determined in the stub-period financial close is a key input to the final HLBV calculation.

2) Familiarity with the partnership’s operating agreement and any accounting policy elections: It is critical that there is familiarity with the provisions of the operating agreement and any accounting policies utilized by the partnership in its HLBV calculation to ensure the income/loss allocation utilized in the HLBV calculation is correct based on the terms of the operating agreement. Generally, the income/loss allocation is calculated based on terms in the operating agreement and these allocation percentages can vary for pre-flip and post-flip periods or other terms.  

3) Consider tax implications and involve tax specialists:

a. Each investor’s 704 (b) capital account should be accurately adjusted and reconciled as of the buyout date as this is another key input to the HLBV calculation.

b. Prior to the buyout, the sponsoring investor holds an investment in a partnership and the deferred taxes that the sponsor records are calculated based on that investment value. Subsequent to the buyout, the partnership typically becomes a single member limited liability company and will be disregarded for federal income tax purposes. Therefore, the deferred taxes that the sponsoring investor records are calculated based on the underlying assets and liabilities of the single member limited liability company. The cash paid by the sponsoring investor in the buyout results in the purchased assets having a cost basis equal to the buyout purchase price and a new depreciable life. This increase in tax basis will result in an adjustment to the deferred taxes recorded by the sponsoring investor and such adjustment for GAAP reporting purposes is required to be recorded through equity under ASC 740-20-45-11.

4) Buyout price: Although the buyout price is a settled and known amount prior to accounting for the buyout, the sponsoring member should ensure the buyout price calculation is properly considered, reviewed, and in-line with the terms of the partnership’s operating agreement. The calculation of a buyout price can range from simple to complex, depending on the terms in the operating agreement. Typical buyout price provisions can involve one or more of the following: a stipulated amount (typically, a percentage of the tax equity investors contributed capital), the fair market value of the investor’s interest, and/or the investor’s claim in HLBV. The fair market value utilized in the buyout price calculation is typically calculated internally by the sponsoring investor or by using a third-party appraiser; so, it is important to validate the correct buyout price. Some of the key considerations in determining the fair market value are:

Revenue projections: Is the asset operating in a merchant environment or under a long-term offtake agreement? Revenue projections are a key input to the calculation of determining the fair market value of the investor’s interest (which is typically calculated based on projected cash flow benefits). There are various merchant forecast providers and various forecast “scenarios”. It is important that the selected forecast accurately represents the asset’s facts and circumstances. 

Discount rate: The discount rate utilized in determining the fair market value can be highly subjective based on the facts and circumstances of the asset and the environment that it operates in. 

Key takeaways

With the passage of the Inflation Reduction Act, it is anticipated that a broader base of sponsoring investors will participate in tax equity structures, continuing to make tax equity buyouts a key issue for finance and accounting departments. The sponsoring investor should be familiar with the income/loss allocation provisions in the partnership’s operating agreement which drives the determination of the noncontrolling interest carrying value for GAAP financial reporting. There are also numerous tax implications ranging from impacts to deferred taxes, calculating 704(b) capital account balances, and the determination of the sponsoring investor’s basis in the underlying assets that need to be considered and addressed. From a finance perspective, the determination of the buyout price can have variable/subjective inputs that can require a significant degree of judgment to help ensure an appropriate buyout price is reached.

To learn more about the Inflation Reduction Act, CohnReznick has published several articles available on our renewable energy industry page.