C.5 Initial Measurement

C.5.1 Initial Recognition of the Cost of a Tax Equity Investment

ASC 323-740

25-3 A liability shall be recognized for delayed equity contributions that are unconditional and legally binding. A liability also shall be recognized for equity contributions that are contingent upon a future event when that contingent event becomes probable. Topic 450 and paragraph 842-50-55-2 provide additional guidance on the accounting for delayed equity contributions.

25-5 An entity shall recognize income tax credits in the period that they are allocated to the investor for tax purposes. Unless all income tax credits are allocated to the investor at the date of initial investment, immediate recognition of the entire benefit of the income tax credits to be received during the term of an investment that generates income tax credits and other income tax benefits from a tax credit program is not permitted (that is, income tax credits shall not be recognized in the financial statements before the year in which the credit arises).

30-1 Paragraph 323-740-25-5 prohibits immediate recognition of income tax credits, at the time of initial investment, for the entire benefit of tax credits to be received over a period of time during the term of an investment that generates income tax credits and other income tax benefits from a tax credit program (that is, income tax credits shall not be recognized in the financial statements before the year in which the credit arises).

Investments accounted for in accordance with ASC 323-740 are initially recognized at cost. The cost of the investment should include (1) the initial investment amount, (2) the amount of any unconditional and legally binding future contributions to be made, and (3) the cost of any future contributions that are contingent on a future event that is determined to be probable. Notwithstanding the reference in ASC 323-740-25-3 to leveraged lease accounting guidance in ASC 842-50-55-2, we believe that these delayed equity contributions are not required to be recognized on a discounted basis. However, we believe that it would also be acceptable for an investor to elect to record delayed equity contributions on a discounted basis. An investor should apply its method of recognizing delayed equity contributions consistently for each tax equity investment that qualifies for use of the proportional amortization method.

Example C-1

Company A executes an investment agreement for a tax equity investment that meets the scope criteria to be accounted for by using the proportional amortization method in accordance with ASC 323-740. The investor has elected to apply that method. As part of the investment agreement, A agrees to pay:

An initial cash investment of $2 million.
An additional $1 million one year after the initial investment.
Up to an additional $0.5 million to fund losses of the investee to fund the investee’s operations.

At the time of the initial investment, A determines that it is not probable that it will be required to invest any additional cash to fund losses of the investee.

As of the date of the initial investment, the amount recognized would include the initial investment of $2 million and the $1 million to be paid one year after the initial investment, with an offsetting liability of $1 million for the future commitment that is unconditional and legally binding. The contingent commitment to fund an additional $0.5 million would not be recognized in the initial investment balance because it was not considered probable.

If, on a future date, A determines that it is probable that it will be required to fund the additional $0.5 million, that amount would be recognized in the investment balance, with an offsetting liability recognized for the same amount. The amortization recognized each period would be prospectively adjusted to reflect the increased investment balance.

For simplicity, assume that the investment is assessed and continues to qualify for the proportional amortization method after this additional investment amount is recognized.

See Section C.6.1 for further interpretive guidance on how to adjust the proportional amortization calculation for commitments to fund that are made, or are contingent and become probable, after the initial measurement of the investment.

C.5.2 Recognizing Deferred Taxes When the Proportional Amortization Method Is Used to Account for a Tax Equity Investment

For an investment accounted for under the proportional amortization method, an entity generally should not record deferred taxes for the temporary difference between the investment’s carrying amount for financial reporting purposes and its tax basis. The proportional amortization method reflects the view that a tax equity investment through a limited liability entity is, in substance, the purchase of income tax benefits. Accordingly, the initial investment is amortized in proportion to the income tax credits and other income tax benefits allocated to the investor, as described in ASC 323-740-35-2. This approach is similar to the accounting for purchased income tax benefits described in ASC 740-10-25-52, which requires that future income tax benefits (net of the amount paid) purchased from a party other than a tax authority be initially recognized as a deferred credit and then recognized in tax expense when the related tax attributes are realized.

Further, while ASC 323-740 does not explicitly state that an entity is not required to recognize deferred taxes for the temporary difference related to its tax equity investments, ASU 2014-01 amended the example in ASC 323-740-55-2 through 55-9 so that it no longer addresses the recognition of deferred taxes for the temporary difference. While ASU 2023-02 further amended the example in ASC 323-740-55-2 through 55-5, the example continues to be silent on the recognition of deferred taxes for the temporary difference.

In the Background Information and Basis for Conclusions of ASU 2023-02, the EITF expressed the view that the proportional amortization method better reflects a tax equity investment’s economics than the equity method of accounting and thus should help users better understand an entity’s tax equity investment. As shown in Column L of the table in Example C-2, if an entity does not record deferred taxes when using the proportional amortization method, there will be a return in all periods that is positive and in proportion to the investment amortization in each respective period. Column P of the table in Example C-2, on the other hand, shows that when deferred taxes are recorded on the investment, a net decrease in income tax expense (or increase in benefit) occurs in early years and a net increase in income tax expense (or reduction of benefit) occurs in later years. We believe that result is less indicative of the overall economics, is more difficult for financial statement users to understand, and is therefore generally inconsistent with the EITF’s overall objectives in ASU 2023-02. Nonetheless, we are aware that others believe that since the asset is an investment, an entity would not be precluded from accruing deferred taxes on the related temporary difference. Entities that take this view are encouraged to consult with their income tax accounting advisers.

We believe that when an entity uses the practical expedient described in ASC 323-740-35-4, as discussed in further detail in Section C.6.3, it should recognize deferred taxes on the investment. Under the practical expedient, the entire cost of the tax equity investment is amortized over only the period during which the income tax credits are received. The period over which “other income tax benefits” such as depreciation will be received may be longer than the period over which income tax credits are generated. When deferred taxes are recognized for the temporary difference, the current tax benefit for the “other income tax benefits” received after the amortization of the investment’s cost is offset by the deferred tax expense resulting from the reversal of the DTA recognized for the remaining tax basis. We believe that when using the practical expedient, an entity should record deferred taxes since doing so better reflects the investment’s performance and thus should help users understand an entity’s tax equity investment, as demonstrated in Column P of the table in Example C-4.

If the practical expedient is used and deferred taxes are not recorded, a reporting entity will recognize “other income tax benefits” in the years after the cost of the investment has been amortized, and those other income tax benefits will not be reduced by the cost of obtaining them in the period in which they are recognized. Incremental expense may result from the investment in early years, and incremental benefit may result in later years. We believe that these results are less reflective of the overall economics of the investment and, again, inconsistent with the overall objectives of the proportional amortization method.

C.5.2.1 Recognizing Deferred Taxes for a Temporary Difference Resulting From a Statutory Reduction in the Tax Basis of a Tax Equity Investment

Certain tax credits, such as ITCs, require a statutory reduction in the tax basis of the underlying asset held by the tax equity investment on the date the income tax credit is generated. This tax basis reduction would result in a reduction of the tax equity investor’s tax basis in the investment, which causes the investor to have a temporary difference in the tax equity investment since this statutory reduction will not result in a corresponding decrease in the investment for financial reporting purposes.

As discussed above, investors in tax equity structures accounted for under the proportional amortization method are not required to recognize deferred taxes related to their tax equity investments (unless the practical expedient is elected).

See Section 12.2.1 of Deloitte’s Roadmap Income Taxes for a discussion of the accounting for temporary differences related to ITCs if the tax equity investor is recognizing deferred taxes.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.