FinTech in Turkey: Overview
Ekin İnal and Ecem Naz Boyacıoğlu provide an overview of FinTech in Turkey.
Changes in a US tax credit for carbon sequestration should make the tax credit more attractive to the tax equity market.
However, the issue will be whether Congress gave a long enough runway for developers to respond to the new incentive and for the tax equity market to become comfortable with the risks in such transactions.
Sequestration projects must be under construction by the end of 2023 to qualify. Tax credits can be claimed for up to 12 years after a project is put in service on the carbon dioxide captured at an industrial facility or power plant and permanently buried, used as a tertiary injectant to recover oil and gas or put to some other commercial use in a manner that disposes of the CO2.
The US government has offered a tax credit to sequester carbon since late 2008. The credit is in section 45Q of the US tax code.
In the past, the tax credit was too small in amount to generate enough activity, and it could only be claimed on the first 75 million metric tons in total carbon dioxide sequestered nationwide. No more tax credits could be claimed by anyone after the year the IRS announced the 75-million figure was reached. This made it impossible to know, when undertaking a project, how much in tax credits a developer would receive.
Congress eliminated the 75-million-ton cap and increased the credit amount for new carbon capture equipment installed on or after February 9, 2018 as part of a rider to a temporary spending bill, called the “Bipartisan Budget Act,” in early February that kept the federal government operating for another three weeks until a more permanent budget deal was worked out later that month.
Congress also made it easier to transfer the tax credits in cases where the person entitled to tax credits is unable to use them.
Carbon capture at older facilities that were in service before February 9, 2018 will continue to qualify for tax credits, but at the old rates and subject to the 75-million-ton cap.
A big coal-fired power plant that emits and captures five million tons of CO2 a year could generate more than $110 million a year in tax credits.
The credit is more likely to lead to transactions at smaller industrial facilities than power plants in the short run because of cost. Costly deals are more complicated and time consuming to put together.
The revamped tax credit for installing new capture equipment — like the old tax credit — rewards capturing carbon dioxide from any industrial source, including a power plant, and then either burying it in a secure geological storage or using it in one of a variety of ways.
The possible uses include injecting it into the ground to help with oil and gas recovery, causing algae or bacteria to absorb it, converting it into a chemical in which the CO2 is securely stored or finding another commercial use for it as CO2. The Internal Revenue Service has the final say about permitted commercial uses. The CO2 would have to be considered permanently disposed.
A credit can also be claimed as a reward for using direct air capture equipment to pull carbon dioxide from everyday air, but not from pockets where it has been “deliberately” released. An example of “deliberate” release is where CO2 is being released from a naturally occurring subsurface spring.
Secure geological storage means stored in places like deep underground saline formations, oil and gas reservoirs and unminable coal seams in a manner that does not allow the CO2 to seep into the atmosphere. The IRS is supposed to work out with the Environmental Protection Agency, Department of Energy and Department of Interior what makes for “secure” storage, but no formal guidelines have been published.
Both the CO2 capture and the disposal or use must be in the United States or in a US possession like Puerto Rico or Guam.
The credit is an amount per metric ton of CO2 captured. The CO2 must be measured both at the point of capture and the point of burial or use.
For commercial uses as CO2 — in other words, the CO2 is not buried underground or used as an injectant at an oil or gas field — the measurement must take into account the lifecyle reduction in CO2 using the same approach the Environmental Protection Agency uses to track lifecycle greenhouse gas reductions. For example, when trying to assess how much greenhouse gas emissions have been reduced by switching to a biomass fuel, EPA looks at the full greenhouse gas emissions from growing, harvesting and transporting the plants that later become the fuel all the way through their use as fuel. Section 211(o)(1)(H) of the Clean Air Act says the “lifestyle greenhouse gas emissions” are the “aggregate quantity of greenhouse gas emissions (including direct emissions and significant indirect emissions such as significant emissions from land use changes) . . . related to the full fuel lifecycle, including all stages of fuel . . . production and distribution . . . .”
The amount of tax credit depends on when the carbon capture equipment was installed and what is done with the CO2.
The tax credit for CO2 captured using older capture equipment placed in service before February 9, 2018 is $22.48 per metric ton if the CO2 is stored securely underground and $11.24 for other uses. These are the 2017 figures. The amounts are adjusted each year for inflation.
For new capture equipment placed in service on or after February 9, 2018, the tax credit is higher. The IRS is supposed to set the credit amounts each year by doing a linear interpolation with the credit rising from $22.66 a metric ton in 2017 to $50 a ton in 2026 for CO2 stored securely underground and from $12.83 in 2017 to $35 a ton in 2026 for other uses. Starting in 2027, the amounts are adjusted for inflation.
The new capture equipment must be at a power plant, factory or other industrial facility that was under construction by the end of 2023. The capture equipment must also be under construction by then or be contemplated as part of the original planning or design for the power plant, factory or other industrial facility.
There may be situations where older capture equipment is upgraded on or after February 9, 2018. If that happens, then the amount of tax credit that can be claimed turns on how extensively the existing equipment was improved. If the spending on improvements is at least four times the value of the equipment retained from the existing system, then the entire system is treated as brand new, and the owner will qualify for the higher, new credit amounts. Otherwise, the CO2 captured must be allocated between the old and new parts based on capture capacity, with the CO2 treated as captured first by the old equipment up to its capture capacity.
It must be clear that the CO2 captured would otherwise have been released into the atmosphere as part of the greenhouse gas emissions from the power plant or other industrial facility. Thus, a power plant cannot scale back other existing means it is using to cut emissions in order to get better economics by tapping into tax credits.
At least a minimum amount of CO2 must be captured to qualify for any tax credits in a year.
Carbon capture from power plants must be at least 500,000 metric tons a year, with one exception.
The carbon capture at power plants, factories and other industrial facilities that emit 500,000 or fewer metric tons a year can be as little as 25,000 metric tons if the CO2 captured will be put to some other use than being buried underground or used as a tertiary injectant to produce oil or gas.
Where direct capture equipment is used to pull CO2 from the air, then at least 100,000 metric tons must be captured in a year.
Tax credits on CO2 captured at new equipment can be claimed for 12 years after the new equipment originally went into service.
Tax credits on older equipment can be claimed only until the end of the year in which the IRS certifies that credits have been claimed on 75 million metric tons of captured CO2 nationwide since October 3, 2008. As of May 10, 2017, tax credits had been claimed on 52,831,877 metric tons.
The tax credits for new capture equipment belong to the person who owns the equipment. Credits for use of older capture equipment belong to the person who uses the equipment regardless of ownership. In both cases, the person claiming the credit must either dispose of the captured CO2 by secure burial or use or contract with someone else to do it.
Often, the person entitled to the tax credits cannot use them. In such cases, the credits can be transferred to the company that disposes of the CO2 by burial or use by making an election on an IRS form.
Alternatively, it may be possible to get value for the credits in the tax equity market.
Any tax equity deal involving new equipment would have to take the form of a partnership flip transaction. That’s because the entity claiming the tax credits must both own the capture equipment and dispose of the CO2 captured or contract with someone else to do it. Thus, as a practical matter, the same entity must both own and use the equipment.
There are several ways to put a partnership flip transaction in place. Two of the more common are the owner of the new equipment would sell an interest in a special-purpose “project company” that owns the capture equipment to a tax equity investor or else the tax equity investor would make a capital contribution to the project company for an interest in the project company, thereby converting the project company into a partnership. Thus, the sponsor and tax equity investor would own the capture equipment through a partnership.
The partnership would enter into a contract with the owner of the power plant or other industrial facility to capture CO2 for it. The partnership would also hire the sponsor or a third party to operate the capture equipment on its behalf. It would contract with one or more third parties to dispose of or buy the CO2.
The tax equity investor would size its investment by discounting the net benefits stream it expects as a part owner of the capture equipment using its target yield as the discount rate. Its net benefits stream would include its expected share of the tax credits, tax savings from any tax losses (including depreciation of the capture equipment) and cash the partnership is able to earn by capturing CO2 for a power plant or other industrial facility and reselling the CO2 for a commercial use. The taxes the tax equity investor would have to pay on its share of partnership revenue would have to be backed out as a detriment.
The partnership would allocate up to 99% of the tax credits to the tax equity investor. Section 45Q credits must be shared by the partners in the same ratio they share in “bottom-line” losses. Thus, for example, if a partnership allocates one type of tax loss in a 50-50 ratio and allocates all remaining losses in a 99-1 ratio, then the section 45Q credits must be shared in a 99-1 ratio. Taking the simplest approach, the partnership would allocate the tax equity investor 99% of income and loss and tax credits until it reaches a target yield, after which the investor’s interest in the partnership would flip down to 5%. The sponsor would have an option to buy the investor’s 5% interest after the flip.
Each partner has a capital account that is a metric for tracking what the partner put into the partnership and is allowed to take out. The investor’s capital account starts with his investment. It goes up as the investor reports taxable income from the partnership. It goes down as the investor reports losses or is distributed cash.
Once the capital account hits zero, any further loss would shift to the sponsor. This would drag tax credits to the sponsor. Therefore, the transaction should be structured to make sure this does not happen. One way may be to write off the full cost of the carbon capture equipment as depreciation in year 1. The cost of assets that a partnership puts in service through 2022 can be deducted entirely in year 1 as a “100% depreciation bonus.” Another way is for the investor to promise to increase its investment if its capital account is still negative when the partnership liquidates. This is a called a “deficit restoration obligation” or DRO. Another way to for the partnership to borrow all or part of the cost of the carbon capture equipment as this turns the depreciation into a type of tax loss that the investor can continue being allocated even after it runs out of capital account.
Small sponsors without track records and good financial metrics will have a hard time raising tax equity.
Most mainstream tax equity investors like deals that require investments of at least $40 to $50 million. They are less keen to do one-off deals than deals with a sponsor who will have a pipeline of projects.
New technologies are nearly impossible to finance. The market is only interested in proven technologies.
There is also the issue of making investors confident in a new market about what amount of sequestered CO2 — and, by extension, tax credits — to project for purposes of sizing their investments. The investor may be willing to invest something up front and make ongoing additional investments as it sees each year how much CO2 was sequestered. However, the IRS generally prefers in such “pay-go” structures that the contingent amounts to be invested over time not be more than 25% of the total investment.
Another risk for investors is the credits are subject to recapture — without time limit unless the IRS adopts one — if the CO2 ends up in the atmosphere. Congress directed the IRS to come up with recapture rules. The issue is not on the current IRS priority guidance plan.
For older capture equipment put in service before February 9, 2018, two tax equity structures are possible in theory — partnership flips and inverted leases — but the 75-million-ton cap on total tax credits nationwide is a serious impediment.
In an inverted lease, the sponsor leases the capture equipment to a tax equity investor. The investor hires the sponsor or a third party to operate the equipment and dispose of the CO2. The investor claims the tax credits and deducts the rent paid to lease the capture equipment. The sponsor keeps the depreciation on the equipment and uses it to shelter the rent. At the end of the lease, the sponsor takes back the equipment.
Ekin İnal and Ecem Naz Boyacıoğlu provide an overview of FinTech in Turkey.
During his State of the Nation Address, the President gave reassuring impetus to solving the current energy crisis and perennial load shedding that has been decimating the economy.