Commercial Solar Energy Credits: A GAAP Accounting Primer
A powerful tax credit designed to encourage construction of energy-producing solar equipment was set to expire next year, before Congress extended its benefits for three more years. A sister article addresses the tax impact of the commercial solar energy credit, while the discussion below will address this credit’s GAAP accounting ramifications. Specifically, it will cover accounting for investments in other entities that construct or acquire qualifying solar equipment – a common structure by which financial institutions encounter this credit. Given the somewhat recent emergence and growing popularity of solar tax equity investments, accounting best practices continue to evolve. Nevertheless, current accounting literature and industry practices provide a reasonable framework from which we can develop the appropriate accounting treatment.
The following considerations assume a partnership-flip transaction structure as these seem to be one of the more common forms of tax equity investment we see. In a typical partnership-flip transaction structure, the tax equity investor has rights to a majority (e.g. 99%) of the partnership’s income, loss and tax credits until a target yield has been . Once the target yield is reached, the tax equity investor’s share is generally reduced to a minimal amount (e.g. 5%) and the developer will have an option to purchase the tax equity investor’s remaining interest.
With this backdrop, the question often comes up: how should a tax equity investor account for its interest in the partnership when the percentage of ownership changes over the life of the solar project?
One of the more common methods of accounting for a tax equity investment under a partnership-flip transaction structure is referred to as the hypothetical liquidation at book value (“HLBV”) method. Under this method, which is based largely on a Statement of Position that was never formally adopted by the FASB, the assets of the project are deemed to be liquidated at GAAP book value, any liabilities are settled, and a hypothetical gain or loss is calculated on the difference between the book value and the tax basis of the partnership. The hypothetical gain or loss is allocated to the partners in the order dictated by the terms of the partnership’s operating agreement (referred to as the “liquidation waterfall”). The capital account of each partner, along with the hypothetical gain or loss allocated to them, is liquidated to reduce their capital account to zero. The amount by which each partner would need to adjust their capital account to bring it to zero is the carrying value of their investment in the partnership.
Application of the HLBV method will generally result in a significant initial write down of the investment which will be largely offset by the tax credits generated by the partnership to which the tax equity investor is entitled. Because these tax credits are recognized in full for book purposes but only result in a 50% tax basis reduction, a deferred tax liability will generally need to be established to reflect this difference. Going forward, the tax equity investor will need to remeasure the investment at each reporting period using the approach outlined above. As with any investment, an institution will need to regularly assess its investment in the partnership for impairment based on its share of future cash flows expected to be generated by the project.
Although the HLBV method is one of the more common methods of accounting for tax equity investments in solar projects, institutions will ultimately need to determine whether another method of accounting (e.g. equity method, fair value option, estimated cash flows) is more appropriate depending on their own facts and circumstances.
For more information or a discussion on how this may impact you, please contact Joseph Jalbert or your BNN advisor at 800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, investment, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.