The Role of Tax Insurance in U.S. and Canadian Renewables Projects

Renewable energy projects require significant upfront investment, and tax incentives play a crucial role in making these projects financially viable. In the United States, financing structures for renewable energy almost always leverage federal tax incentives like the Investment Tax Credit (ITC) and the Production Tax Credit (PTC).  The volume and complexity of U.S. legislation create meaningful uncertainties in applying the tax credit rules.  Tax insurance has emerged as a critical tool to mitigate risks associated with potential changes or challenges to the tax treatment of U.S. incentives.

Renewable energy financing structures in Canada operate under a different and evolving tax regime, and it is unclear how much of a role tax insurance will play in Canadian renewables projects in the future.

Tax Insurance in U.S. Renewable Energy Financing

In the U.S., tax equity financing is the dominant structure for funding large-scale renewable energy projects. These projects typically rely on tax incentives, such as the ITC and PTC, to attract capital. Tax equity investors provide financing in exchange for a portion of these credits, which they can use to offset their federal tax liabilities.

However, the eligibility for tax credits can sometimes be challenged by the IRS or be affected by regulatory changes. This is where tax insurance can add significant value. Tax insurance is designed to protect investors from the risk that these credits could be disallowed, reduced, or invalidated. The insurance covers potential financial losses if the tax benefits are not realized as expected, providing security to project developers, tax equity investors and tax credit acquirers.

The U.S. Inflation Reduction Act created an even stronger case for the use of tax insurance by introducing the transferability of credits as an approach to monetizing those credits, thus enabling a significant number of new potential tax credit acquirers.  These new acquirers often have little to no experience with the U.S. renewables tax credit rules and have potentially limited access to project due diligence information.  This lack of background and factual information makes tax insurance a key tool for enabling tax credit buyers to gain comfort that the credits they acquire will result in a predictable economic return.  In turn, tax credit sellers that can demonstrate ready access to tax insurance can gain an edge both in liquidity of the credits they wish to sell and improved pricing (uninsured credits are typically discounted in the markets more than 100% of the cost of insuring the credits).

Key U.S. Financing Structures Utilizing Tax Insurance

1. Partnership Flip Structures: In this model, tax equity investors initially receive most tax benefits, such as ITCs or PTCs. After they reach a certain return threshold, the ownership “flips,” and the sponsor receives a larger portion of the cash flows (these structures are colloquially referred to as “P-Flips” (Partnership Flips)). Tax insurance ensures that the allocation of tax credits is not later challenged, which could affect returns.  Post-IRA, most partnership flip structures include the option for the partnership to sell some or all of the tax credits generated by the project to a third party.  These structures are colloquially referred to as “T-Flips” (Transferability Flips).
2. Sale-Leaseback Structures: A developer sells a renewable energy project to a tax-equity investor, who leases it back to the developer. The tax credits are claimed by the tax equity investor, and tax insurance protects against the risk of credit disallowance or incorrect structuring.
3. Inverted Leases: In this model, the tax equity investor leases the equipment to the project developer, who uses it and transfers the tax credits to the investor. Tax insurance ensures that the legal structure allowing for this transfer remains valid.

How Canadian Financing Structures Differ

In Canada, renewable energy projects historically did not rely on direct federal tax credits like the ITC or PTC. Instead, Canadian renewable energy financing tended to revolve around accelerated depreciation (such as the Accelerated Capital Cost Allowance, or CCA), grants, and subsidies.  Therefore, tax insurance played a less prominent role in Canadian financing structures.

Canada’s Clean Energy Investment Tax Credit (CEITC), introduced in the 2023 federal budget and effective in 2024, provides a 30% refundable investment tax credit for businesses investing in renewable energy technologies. This credit is aimed at encouraging the development and deployment of clean energy solutions like solar, wind, hydro, and nuclear energy.  The CEITC, in many ways, resembles the U.S. ITC regime. However, Canada did not implement the transferability of CEITCs, a key feature of the IRA.  Instead, Canadian rules provide for the refundability of excess CEITCs.

Due to the recent enactment of the CEITC provisions, it is unclear whether financing structures similar to those implemented in the U.S. will be employed. It should be noted that some hurdles under Canadian tax rules could make these structures harder to deploy. For example, there may be hurdles under the Canadian partnership rules to establish a “tax equity” structure.

Key Historical Canadian Financing Structures

1. Capital Cost Allowance (CCA) Structures: The CCA allows businesses to deduct the cost of renewable energy equipment more quickly, reducing taxable income in the early years of the project. This accelerated depreciation creates a similar incentive as U.S. tax credits but with a reduced need for tax insurance, as the risk of depreciation being disallowed is typically considered minimal.
2. Government Grants and Subsidies: Canadian provinces often provide direct grants, rebates, and performance-based incentives to promote renewable energy adoption. While these programs reduce upfront costs, they don’t typically involve the same complexities and risks associated with tax credits in the U.S., which means tax insurance has rarely been needed related to these benefits.
3. Provincial Net Metering and Power Purchase Agreements (PPAs): In some provinces, renewable energy developers can benefit from long-term PPAs or net metering programs, which provide stable revenue streams by selling energy back to the grid or offsetting energy costs. These agreements offer financial risk mitigation, reducing the historical need for tax-based financial structuring.

Conclusion

While tax insurance is a key feature of U.S. renewable energy financing structures, primarily due to the heavy reliance on federal tax credits, Canadian renewable energy projects historically operated in a tax regime that placed greater emphasis on accelerated depreciation and direct subsidies. As a result, Canadian financing structures have been less dependent on tax insurance.   It remains to be seen whether demand for tax insurance for Canadian renewable energy projects will increase now that Canada has implemented an ITC regime.