Common Control Accounting Considerations for Renewable Energy Transactions
U.S. solar installations totaled 129 GW through the middle of 2022 and are tracking to be greater than 236 GW by 2025, according to Wood Mackenzie’s Q3 2022 global solar PV market outlook update. The growth trajectory of the industry requires financing in different forms including sponsor equity, as well as debt and tax equity. Solar projects generate significant tax benefits in the form of investment tax credits and tax losses driven from depreciation which continue to be a key to successfully financing projects. To maximize these tax benefits there are various structures used including date-certain partnership flips, target-yield partnership flips, sale and leaseback transactions, and inverted lease or passthrough structures. Frequently, the date-certain partnerships and target yield partnership flip structures acquire the solar assets from an entity under common control (typically the ultimate parent of the sponsor member of the partnership or fellow subsidiary of that parent) at their fair market values in order to maximize the tax benefits to the investors.
The form of these common control transactions often includes the developer/sponsor entity selling 100% of the membership interest of a special purpose entity holding solar assets into a Tax Equity Partnership (Partnership) where the developer/sponsor retains the managing member interest and a tax equity investor holds the limited partner interest or 99% of the Partnership. This results in the investment tax credits and depreciation benefits being stepped up for tax purposes based on the purchase price paid by the Partnership for the assets. Accounting Standards Codification (ASC) 805, “Business Combinations,” which provides guidance for the accounting of business combinations, specifically scopes out transactions which are between entities under common control and requires ASC 805-50 guidance to be applied to account for these transactions.
Because a transfer of membership interest between entities under common control does not change an ultimate parent’s control, the consolidated financial statements of the ultimate parent will not be impacted by such transactions. At the time of acquisition, the commonly controlled entity to which the membership interest is transferred recognizes the transaction using carrying value of the ultimate parent. Similarly, the selling entity, which is commonly controlled, would not recognize gain on sale but would account for the transfer of membership interest through its equity accounts. The impacts of the accounting guidance that follows pertain to the financial reporting of the subsidiary buyer or Partnership and seller entities.
ASC 805-50, Transactions Between Entities Under Common Control discusses accounting for the acquisitions and sales between such entities. Although GAAP does not define common control, the definition of control that is generally applied is found in ASC 810, “Consolidation”, in which control can be established by owning the majority of voting interests in an entity or control can be established through the variable interest entity model or through control by contract, both of which are found in ASC 810. According to ASC 805-50, a summary and brief discussion on certain key elements to the accounting guidance for a transfer of assets or exchange of shares between entities under common control follows below:
- Accounting guidance for business combinations within ASC 805-10 does not apply to entities under common control
- The following are examples of such common control transactions but are not all inclusive:
- An entity charters a newly formed entity and then transfers some or all of its net assets to that newly chartered entity.
- A parent transfers its controlling interest in several partially owned subsidiaries to a new wholly owned subsidiary. That also is a change in legal organization but not in the reporting entity.
- A parent exchanges its ownership interests or the net assets of a wholly owned subsidiary for additional shares issued by the parent’s less-than-wholly-owned subsidiary, thereby increasing the parent’s percentage of ownership in the less-than-wholly-owned subsidiary but leaving all of the existing noncontrolling interest outstanding.
- The entity that receives the net assets or the equity interests shall initially recognize the assets and liabilities transferred at the date of transfer and shall initially measure the recognized assets and liabilities transferred at their carrying amounts in the accounts of the transferring entity at the date of transfer or at the historical cost basis of the controlling parent if that basis is different than the transferring entity on the date of transfer, for example, because pushdown accounting had not been applied.
- The financial statements of the receiving entity shall report results of operations for the period in which the transfer occurs as though the transfer of net assets or exchange of equity interests had occurred at the beginning of the period. The effects of intra-entity transactions on current assets, current liabilities, revenue, and cost of sales for periods presented, and on retained earnings at the beginning of the periods presented, shall be eliminated to the extent possible.
- Similarly, the receiving entity shall present the statement of financial position and other financial information as of the beginning of the period as though the assets and liabilities had been transferred at that date.
- Financial statements and financial information presented for prior years also shall be retrospectively adjusted to furnish comparative information, if the entities were under common control during that period. All adjusted financial statements and financial summaries shall indicate clearly that financial data of previously separate entities are combined.
The sale of the assets from the developer/sponsor is usually at fair market value and should be based on an appraisal of the underlying assets. The Partnership that purchased the assets will be able to receive the benefits of the investment tax credits (ITC) and depreciation expense based on the purchase price paid to acquire the assets even though GAAP does not permit the step up in basis.
Upon the acquisition of the assets from a commonly controlled entity the Partnership will record the transferred assets and liabilities at the carrying amounts of the transferor on the date of the transfer for book purposes. The carry over asset basis frequently causes questions on how to account for the difference between the price paid for the assets by the Partnership and the historical carrying amount of the assets on the date of transfer. Any cash paid in excess of the carrying amount on the transfer date will be recorded as an equity transaction or dividend (a deemed distribution) for book purposes. This accounting will usually create a book to tax difference for the basis of the assets.
ASC 805-50 does not provide any direct guidance on the accounting of the transferor entity for transactions between entities under common control. In practice, any gain on recognition of the sale or transfer would typically be treated as an equity transaction similar to the buyer entity.
In practice, there are many more sales of solar assets than wind assets between entities under common control, as discussed below:
Solar assets (prior to the passage of the Inflation Reduction Act in August 2022) are only eligible for ITCs (rather than the production tax credit (PTC) which is allowable starting in 2023). The amount of ITCs eligible to be claimed are based upon a percentage of the basis of the eligible energy property placed into service each taxable year. By selling assets into a partnership based on their fair market value the basis of the eligible energy property will usually be increased.
Although wind assets can elect the ITC, this is not often done in practice based on wind assets being able to elect the PTC. PTCs are earned as the wind facility produces energy, over a ten-year period, and are not based on the cost basis of the asset, thus common control sales are rarely done for tax structuring of wind assets.
With the passage of the Inflation Reduction Act, (read CohnReznick’s analysis and breakdown of the bill here), the future for the tax credit incentivized investment in renewable energy looks promising; although, it is presently unclear on how the market will adapt and how these deals will be structured after the passage of the Inflation Reduction Act. The Inflation Reduction Act, starting in 2023, will allow solar energy property to claim PTCs in-lieu of ITCs. This change in legislation creates the possibility that tax equity investors in solar projects will pivot to PTC election based on the economics of each deal; however, traditional structures for solar deals are expected to remain prevalent.
Although renewable energy tax incentivized investments are continually evolving, common control transactions are a key element of the structuring for these transactions that reporting entities need to be aware of in order to properly account for them. The receiving entity of assets from a seller should carefully evaluate all facts, circumstances, and related party relationships when determining the accounting for these types of transactions.
To learn more about the accounting for business combinations not between entities under common control, CohnReznick has published a three-part series on the topic found here.
Brian Marconi, CPA, Partner, Renewable Energy Industry
John Sipe, CPA, National Assurance
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