For U.S. Territories, IRA Tax Credits Remain A Complicated Question

The Inflation Reduction Act includes U.S. territories in the expansion of clean energy tax benefits, but only partially. The proposed elective payment regulations (REG-101607-23) define when territories and entities within them can benefit from the new regime.

The proposed rules provide that applicable entities include U.S. territories and their political subdivisions, instrumentalities, and agencies, similar to the provision for the states and the District of Columbia.

But unlike the states and the District, territories are not expressly listed in section 6417(d)(1)(A). In response to stakeholder comments, the proposed regs explain that territorial governments are indeed applicable entities because they are organizations “exempt from the tax imposed by subtitle A” under section 6417(d)(1)(A)(i).

Territories are also mentioned in section 6417(f), which provides that for U.S. territories with a mirror code tax system, the elective payment provision isn’t part of the mirror code unless the territory elects to include it. That gives the territories with mirror codes (Guam, the Northern Mariana Islands, and the U.S. Virgin Islands) the option not to adopt elective payment and, accordingly, not to fund it.

Puerto Rico and American Samoa are not required to use mirror codes, and Puerto Rico does not, while American Samoa has a mirror code that doesn’t automatically incorporate any tax law changes made after December 31, 2000.

Territories vs. Possessions

A note about nomenclature is in order. Readers should heed a footnote in the proposed regulations under section 6417 that translates the term Congress used in section 6417(f) — “possession” — to “territory” in the proposed rules. Treasury didn’t explain why it made this change, but the footnote calls it an “alternative term.”

There’s ambiguity here, because alternative doesn’t necessarily mean synonym or imply that the terms are coextensive — an alternative is a substitute choice, but substitutes may be quite different.

Treasury might point to the territories clause of Article IV, section 3, which only references territories, as the basis for its alternative. Regardless of what the Constitution says — and it also says “Territory, or Possession” elsewhere — Congress has been mostly consistent when writing the tax law. Multiple code sections refer to “possessions,” including section 937, which establishes the residence and source rules, as well as the foreign tax credit in section 901. Section 7608(c)(1)(A) refers to both “territories and possessions,” and the sole use of territories on its own is in the individual mandate of the Affordable Care Act (section 5000A(f)(3)(B)).

But Treasury seems inclined to use territory in regulatory guidance, as in the Opportunity Zone regulations (reg. section 1.1400Z2(d)-1(a)(1)(ii)(B)). Congress wrote “possession” in section 1400Z-1(c)(3), so practitioners should take note: For purposes of tax regulation, it appears that Treasury considers territory and possession to be largely, and possibly entirely, synonymous.

But if it does, it should say so expressly, apply the term universally, include it in the text of the regulations and not merely a footnote in the preamble, and get Congress on board, too.

Section 50(b)(1) and the Territories

Section 50(b) applies to all the credits in sections 46 through 48E. The alternative fuel vehicle refueling property credit in section 30(e)(3) says that “no credit shall be allowable under subsection (a) with respect to any property referred to in section 50(b)(1).”

The clean vehicle credit in section 30D(f)(4) says that “no credit shall be allowable under subsection (a) with respect to any property referred to in section 50(b)(1).” And the section 45W credit for qualified commercial clean vehicles incorporates rules similar to those of section 30D(f). Accordingly, the proposed transferability and elective payment regulations apply the section 50(b)(1) rules to eligible taxpayers (in the case of transfers) and applicable entities (in the case of elective payments).

Section 50(b)(1)(A) provides that “no credit shall be determined under this subpart with respect to any property which is used predominantly outside the United States.”

The United States in this context means only the states and the District of Columbia, not the territories. Section 50(b)(1)(B) provides an exception from that rule for “property described in section 168(g)(4),” which includes property owned by a domestic corporation or U.S. citizen (except those entitled to the benefits of section 931 or 933, which covers bona fide residents of Guam, American Samoa, the Northern Mariana Islands, and Puerto Rico) that is used predominantly within a U.S. territory, or by a corporation of the territory.

New York University’s Tax Law Center pointed out in its comment letter that the proposed regs “take a reasonable — but not compelled — interpretation of pre-existing law and how it interacts with the IRA” that precludes territory governments and other entities using credit property in the territories from “seeking an elective payment for investment tax credits under sections 48 and 48E, the clean vehicle and charging credits under sections 45W and 30C, and the advanced manufacturing credit under section 48C.”

The center asked that Treasury allow entities in the territories to claim elective payment on ITCs and transfer credits when they otherwise meet the eligibility requirements. It wrote:

“Ensuring full access for IRA credits for projects located in the territories is squarely within the set of access challenges that lawmakers have historically sought to address using various monetization mechanisms, given the unique status of territories and the specific energy security challenges faced by their residents, businesses, and governments.”

Territory governments are also precluded from applying for the low-income communities bonus credit because of the application of section 50(b)(1), the center explained.

The trouble is the phrasing in section 168(g)(4)(G), which suggests that there’s an ownership requirement — meaning the property must be “owned by a domestic corporation or by a United States citizen” who isn’t a bona fide resident of one of the territories, except the U.S. Virgin Islands — and a requirement that the property be predominantly used in a territory by the domestic corporation, U.S. citizen, or a corporation organized in the territory.

The IRS has an FAQ on the application of the IRA credits to the territories that seems to confirm this interpretation. It says, “Property used in the territories and owned by a territory government, or an entity created in or organized under the laws of a U.S. territory generally would not qualify for the section 30C, 45W, 48, 48C, and 48E credits. However, these restrictions do not apply to the production credits eligible for elective pay (sections 45, 45Q, 45U, 45V, 45X, 45Y, and 45Z).”

In the preamble to the elective payment proposed regulations, Treasury and the IRS explain that “tax-exempt entities in the U.S. territories are eligible to make an election under section 6417.”

But under the proposed rules, those entities are considered organizations exempt from the tax imposed by subtitle A as long as they are exempt from taxation by section 501(a) and meet the requirements to claim an applicable credit. Meeting the requirements includes being an appropriate owner of an investment credit property under sections 50(b)(1)(B) and 168(g)(4)(G).

A footnote in the preamble explains, “In the case of entities, section 168(g)(4)(G) describes property which is owned by a domestic corporation and which is used predominantly in a U.S. territory by such a corporation, or by a corporation created or organized in, or under the law of, a U.S. territory.”

Because of the application of section 50(b), “for U.S. citizens who are not residents of the territories and for U.S. corporations, but not for other persons, property used in the territories can generally qualify for ITCs,” the Tax Law Center explained.

The IRS doesn’t appear to have issued many interpretations of section 168(g)(4)(G), but there is one notably expansive interpretation of the subsection that it repeated in a series of relatively recent private letter rulings.

Among them are LTR 201943021 and LTR 201426013, which say that section 168(g)(4)(G) applies to domestic partnerships for which all of the partners are domestic corporations or are U.S. citizens not entitled to the benefits of either section 931 or 933. (When Congress enacted the predecessor to section 168(g)(4)(G), which had identical language, the Senate Finance Committee report referred to U.S. persons, and not only to corporations or citizens.)

The result of the application of section 50(b)(1) to section 6417 elections is “a complex, confusing, and seemingly-arbitrary system for determining whether projects in territories are eligible for certain credits,” the Tax Law Center wrote. Taxpayers in the territories could form U.S. corporations to access ITCs, and that might be what they do.

Puerto Rico’s deputy treasury secretary, Angel Pantoja Rodriguez, wrote a comment letter on the proposed regs in support of the plan to include territorial governments and instrumentalities as applicable entities, but asked the government to further clarify that whether an entity is considered an instrumentality should be determined with respect to local law.

He asked that the final definition of instrumentality include public-private partnerships, pointing out that Puerto Rico’s power utility is a wholly government-owned instrumentality of the Puerto Rican government but has assets that are operated and maintained by a private partner.

What did Congress intend for the application of the IRA’s tax provisions to the territories? The bill refers to the territories in several places.

There is the mention of mirror codes in section 6417(f) and the express provision for hydrogen production in territories in section 45V(2)(B)(i)(I). For purposes of section 25D’s residential clean energy credit, “specified tax-exempt entity” is defined in part as “the United States, any State or political subdivision thereof, any possession of the United States, or any agency or instrumentality of any of the foregoing.”

Dealers are defined as anyone licensed to sell vehicles in Puerto Rico and “any other territory or possession” for purposes of section 30D. The advanced manufacturing production credit in section 45X included the territories in defining production in the United States, as did the section 45Z clean fuel production credit. The production credit in section 45Y did likewise, in addition to defining qualified carbon dioxide as including carbon dioxide captured and disposed of or used in a territory.

Legislative history might have helped Treasury ascertain Congress’s intent as to the elective payment regime, but lawmakers failed to provide any.

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