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Recapture isn’t a new concept in the world of investment tax credits. Section 50, where the recapture provisions are found, has been in the tax code since 1990.
The basic concept is if the investment tax credit is taken with respect to property, and that property is sold (or otherwise becomes ineligible) within five years after the property becomes operational, a tax is due. The tax is basically equal to the credit allowed on the property multiplied by a percentage. The percentage starts at 100% and is reduced by 20% each year after the relevant property is placed in service. For example, if a taxpayer took an investment tax credit of $1,000,000 attributable to the construction of a solar energy facility and sold the solar energy facility between the third and fourth year, the recapture amount percentage would be reduced by 60% (20% for each year held) to 40% and the amount subject to recapture would be $400,000 ($1,000,000 * 40%).
One important question is who will be responsible for this tax when the tax credit is transferred. Is the onus on the buyer or seller? To highlight how prevalent this question is, there were 121 comment letters submitted to the IRS that mentioned 6418, the section of the code that covers transferability. Of those, 46 mention recapture. That means almost 40% of the comment letters related to transferability of tax credits touched on recapture in one way or another. While questions about how transferability and direct pay works inside of partnerships may have been discussed in more comment letters, recapture may be next.
Given the number of comments, whether the buyer or the seller of a tax credit is responsible for recapture is likely to be one of the topics Treasury addresses in regulations or other guidance. As they do this, they will be taking into account the language in the statute to guide their decisions making and will look to policy to the extent that the statutory intent is not clear in the text or otherwise. While we wait for guidance, we thought we’d share our thoughts on what they should decide. In Part I of this analysis, we focus on the policy. In Part II, we focus on the language used in the statute. In both cases, it seems pretty clear that the onus of recapture should fall on the seller.
Starting with the policy, it seems pretty clear that policy would weigh in favor of placing the cost of any recapture on the seller of the tax credit. As we noted in our prior comment letter to Treasury regarding the transferability of credits, it doesn’t make any sense to place the onus on the buyer.
First, this is something that the buyer has no control over and the seller has complete control over. It would seem odd to put that cost on the buyer.
Second, because the seller has control, the buyer will likely require an indemnification from the seller if the buyer is subject to tax in connection with a recapture. This is expected to be the case in all transactions in Atheva’s marketplace. However, such a process creates a lot of friction without any particular benefit. The cost of that friction will be lower costs for transferable credits which ultimately means less capital for those creating green technologies which ultimately means less green technologies. So, placing the onus on the buyer would go directly against the goal of transferability which was to increase the development of green technologies.
Third, placing the onus on the buyer would seem to be more likely to lead to non-compliance. If a seller provides a notice to the IRS that it has sold the investment credit property and the seller is responsible for the recapture payment, it would seem likely that the seller would pay the recapture amount and it would be relatively easy for the IRS to connect the dots if payment is not made. On the other hand if the seller provides notice and the buyer has to make the payment, there is an increased likelihood that notice may not be received by the buyer or that the buyer may not account for that notice properly leading to increased risk of non-compliance simply because of the additional steps in the process.
Fourth, placing the onus on the buyer would likely be more difficult to audit. In a case in which the seller provides notice that it has sold the investment credit property, the IRS would need to connect those dots to the right buyer and then would need to track the payments by that buyer to determine if the recapture amount was made. Certainly, it would be possible to do this, but it also would certainly be harder and require additional investment to be able to do this effectively.
In a case in which the seller does not provide the notice, it is unclear how the IRS would ever effectively audit this failure if the onus is on the buyer. If the buyer is under audit, all the buyer can say is that the seller has not provided it with a notice. There is nothing else the buyer can offer to indicate that the property was not transferred by the seller. The IRS would effectively have to audit both the buyer and the seller with respect to that property to determine if it was transferred. On the other hand, if the onus was on the seller, the IRS could explore the issue as part of an audit of the seller and ask for proof that the property was not sold if it was concerned that the property was not subject to recapture.
It seems clear that the policy weighs in favor of placing the onus of recapture on the seller. In Part II of this piece, we’ll focus on the statutory language and how that also leads to a conclusion that the burden of recaptures should lay with the seller.
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