D.3 Scope
ASC 323-740
15-1A
The guidance in the Proportional Amortization Method
Subtopic applies to equity investments that generate income
tax credits and other income tax benefits from a tax credit
program through limited liability entities that are
flow-through entities for tax purposes, meet the criteria to
be accounted for using the proportional amortization method
in this Subtopic, and for which that method is elected on a
tax-credit-program-by-tax-credit-program basis in accordance
with paragraph 323-740-25-4. Additionally, the disclosure
requirements in paragraphs 323-740-50-1 through 50-2 shall
be applied to all investments that generate income tax
credits and other income tax benefits from a tax credit
program for which the entity has elected to apply the
proportional amortization method, including investments
within that elected program that do not meet the conditions
to apply the proportional amortization method.
25-1 A
reporting entity that invests in projects that generate
income tax credits and other income tax benefits from a tax
credit program through limited liability entities (that is,
the investor) may elect to account for those investments
using the proportional amortization method (described in
paragraphs 323-740-35-2 and 323-740-45-2) if elected in
accordance with paragraph 323-740-25-4, provided all of the
following conditions are met:
a. It is probable that the income tax credits
allocable to the investor will be available.
aa. The investor does not have the ability to
exercise significant influence over the operating
and financial policies of the underlying
project.
aaa. Substantially all of the projected benefits
are from income tax credits and other income tax
benefits (for example, tax benefits generated from
the operating losses of the investment). Projected
benefits include, but are not limited to, income tax
credits, other income tax benefits, and other
non-income-tax-related benefits, including
refundable tax credits (that is, those tax credits
not dependent upon an investor’s income tax
liability). Tax credits accounted for outside of the
scope of Topic 740 (for example, refundable tax
credits) shall be included in total projected
benefits, but not in income tax credits and other
income tax benefits when evaluating this condition.
This condition shall be determined on a discounted
basis using a discount rate that is consistent with
the cash flow assumptions utilized by the investor
for the purpose of making a decision to invest in
the project.
b. The investor’s projected yield based solely on
the cash flows from the income tax credits and other
income tax benefits is positive.
c. The investor is a limited liability investor in
the limited liability entity for both legal and tax
purposes, and the investor’s liability is limited to
its capital investment.
25-1A
In determining whether an investor has the ability to
exercise significant influence over the operating and
financial policies of the underlying project, a reporting
entity shall consider the indicators of significant
influence in paragraphs 323-10-15-6 through 15-7. In
considering the operating and financial policies of the
underlying project, the investor shall consider the
operations, financial decisions, and related objectives of
the project as a whole.
25-1B
Other transactions between the investor and the limited
liability entity (for example, bank loans) shall not be
considered when determining whether the conditions in
paragraph 323-740-25-1 are met, provided that all three of
the following conditions are met:
a. The reporting entity is in the business of
entering into those other transactions (for example,
a financial institution that regularly extends loans
to other projects).
b. The terms of those other transactions are
consistent with the terms of arm’s-length
transactions.
c. The reporting entity does not acquire the
ability to exercise significant influence over the
operating and financial policies of the underlying
project as a result of those other
transactions.
ASC 323-740 permits entities to elect, as an accounting policy on a
tax-credit-program-by-tax-credit-program basis, to account for tax equity
investments that meet certain criteria by using the proportional amortization
method. Before applying the guidance in ASC 323-740, a reporting entity must first
consider whether it is required under ASC 810 to consolidate a tax equity
investment. If consolidation of the investment is required, the proportional
amortization method cannot be used.
If the tax equity investment is not consolidated, ASC
323-740-25-1 permits the investor(s) to elect to use the proportional amortization
method as long as all of the following five criteria are met:
- “It is probable that the income tax credits allocable to the investor will be available” (see Section D.3.1).
- “The investor does not have . . . significant influence over the [underlying project]” (see Section D.3.2).
- “Substantially all of the projected benefits are from income tax credits and other income tax benefits” within the scope of ASC 740 (see Section D.3.3).
- “The investor’s projected yield based solely on the cash flows from the income tax [benefits] is positive” (see Section D.3.4).
- “The investor is a limited liability investor in the limited liability entity for both legal and tax purposes, and the investor’s liability is limited to its capital investment” (see Section D.3.5).
D.3.1 Availability of Income Tax Credits
Under the first scope criterion that must be met for an investor
to elect to use the proportional amortization method, it must be probable that
the income tax credits allocable to the investor will be available. The ASC
master glossary defines probable as “[t]he future event or events are likely to
occur.” If an investor has previously established an accounting policy to define
probable for use in the application of other U.S. GAAP, it should use that same
policy when evaluating this scope condition.
For tax credit programs that generate credits over time (e.g.,
production tax credits [PTCs] or LIHTCs) rather than at a point in time (e.g.,
ITCs), an investor should assess whether it can reasonably expect income tax
credits generated over the life of the investee to be available for distribution
to the investor. This assessment should be made in the context of whether it is
probable that the investee will continue to qualify to participate in the
underlying income tax credit program and will continue to generate income tax
credits.
D.3.2 Significant Influence
Under the second scope criterion that must be met for an
investor to elect to use the proportional amortization method, the investor
cannot have the ability to exercise significant influence over the operating and
financial policies of the underlying project.
While an investment in a tax equity structure may provide the investor with an
ownership interest in the project that generally results in the presumption of
significant influence in the application of the guidance on equity method
investments (see Section 3.2), ASC
323-740-25-1A excludes reference to any such thresholds. As noted in paragraph
BC12 of ASU 2014-01, the EITF’s intent in reaching the conclusions in the ASU
was “to identify those investments that are made for the primary purpose of
receiving tax credits and other tax benefits” and to allow an investor to elect
the proportional amortization method to account for such investments. Further,
the EITF believed that “an investor who has the ability to influence the
operating and financial policies of the limited liability entity should not be
precluded from [electing the proportional amortization method] as long as that
investor does not have the ability to exercise significant influence.” In
accordance with its objective, the EITF concluded that the presumption that an
investor can exercise significant influence at 20 percent or more voting stock
ownership would not be applicable to investments in entities since that
presumption “was intended for application to investments in common stock and not
to investments in limited liability partnership interests.” Although the EITF
did not indicate that the quantitative thresholds typically associated with an
investor possessing significant influence over a partnership would not be
applicable to a tax equity investment, it is reasonable to conclude, on the
basis of the EITF’s stated objective, that an investor would not be required to
consider the guidance in ASC 323-30 that a 3 percent to 5 percent ownership
interest in a partnership constitutes significant influence over the
partnership. Rather, the qualitative indicators included in ASC 323-10-15-6 and
15-7 should be considered to determine whether an investor has significant
influence.
As a result, an investor that holds the majority of limited partnership interests
(e.g., 99 percent of the limited partnership units) in a tax equity investee may
be able to conclude that it does not have the ability to exercise significant
influence over the operating and financial policies of the underlying project
depending on facts and circumstances. If the investor concludes that it
participates in the policy-making processes of the underlying project, it would
be deemed to have significant influence and would not be eligible to apply the
proportional amortization method to account for its investment. In addition to
the indicators of significant influence discussed in Section 3.3, factors to consider in the determination of whether
an investor participates in the policy-making processes of the underlying
project of a tax equity investee include the following:
- Does the investor have the ability to make decisions about the day-to-day operations of the project?
- If the rights are substantive, does the investor have the ability to vote on operating and capital budgets of the project or otherwise participate in making decisions about the day-to-day operations without cause? In such circumstances, professional judgment may need to be applied.
The existence of protective rights would generally not provide the investor with
significant influence over the underlying project of the tax equity
investee.
When deliberating the amendments that would ultimately become
ASU 2023-02, the EITF considered whether the criteria in ASC 323-740-25-1(aa),
as discussed above, (1) should be retained and (2) were operable as currently
worded in the application of the condition to a broader set of tax equity
investments. As noted in paragraph BC17 of ASU 2023-02:
The Task Force decided to clarify how to apply the
significant influence condition in paragraph 323-740-25-1(aa) when a
structure is multitiered, such as in an NMTC investment structure. In
multitiered structures, there are several flow-through entities between
the tax equity investor and the project itself, and therefore some
stakeholders indicated that it was unclear at which entity in the
structure the evaluation of significant influence should occur. The Task
Force determined that the project investment structure itself must be
looked at holistically to avoid structuring opportunities.
As a result of this clarification, ASC 323-740-25-1(aa) was
modified to note that an investor should evaluate whether it has significant
influence over the underlying project taken as a whole rather than over a
specific limited liability entity within the tax equity structure. This
modification is not expected to change the application of the significant
influence criterion to tax equity investments that are not made through
multitiered structures (e.g., LIHTC structures).
D.3.3 Substantially All of the Projected Benefits
Under the third scope criterion that must be met for an investor
to elect to use the proportional amortization method, substantially all of the
projected benefits of the investment must be derived from income tax credits and
other income tax benefits, such as operating losses.
When evaluating this scope condition, an investor should
calculate, on a discounted basis, a ratio in which (1) the numerator includes
only the income tax credits within the scope of ASC 740 and other income tax
benefits (net of income tax expense, if any) expected to be realized from the
investment and (2) the denominator includes all benefits expected to be realized
from the investment.
If an investment is expected to generate income tax expense along with income tax
benefits (e.g., income tax expense generated from an investee’s taxable income),
the net amount of income tax benefits would be used in this ratio to determine
whether this criterion is met.
All benefits and income tax expenses expected to be received
throughout the life of the investment should be considered in the evaluation of
this criterion. This can be accomplished by considering either (1) all of the
benefits and income tax expenses to be received by the investor until the
anticipated end of the underlying tax equity project’s life or (2) all of the
anticipated benefits and income tax expenses until the anticipated flip date or
the date of exit by the tax equity investor. If this second approach is taken,
investors also need to include any benefits and income tax expenses expected to
be generated upon exit (e.g., the exercise price of a put or call option that
would be used to exit the investment or proceeds from the anticipated sale of an
investment, along with the income tax expense if there is a taxable gain upon
exit).
In the evaluation of the criterion in ASC 323-740-25-1(aaa), as
amended by ASU 2023-02, only tax credits and other net tax benefits within the
scope of ASC 740 should be included in the numerator of the substantially all
ratio. As noted in paragraph BC18 of ASU 2023-02, the EITF determined that:
[T]he existence of refundable tax credits (that is, tax
credits that are not within the scope of Topic 740) does not preclude an
entity from applying the proportional amortization method to that
investment. However, the Task Force decided that when evaluating this
condition, refundable tax credits are considered to be part of total
projected benefits but not included as an income tax credit or “other
income tax benefit.”
Therefore, in the evaluation of this condition, income tax
credits accounted for outside of the scope of ASC 740 should be included in
total projected benefits (the denominator) but not in income tax credits and
other income tax benefits (the numerator).
However, the EITF did not consider or provide guidance on the
applicability of the proportional amortization method to transferable income tax
credits. It may be appropriate to include transferable income tax credits in
income tax credits and other income tax benefits (the numerator), depending on
how the investor has elected to account for transferable income tax credits. If
any of the tax credits generated by the investee are transferable credits, an
investor will need to consider its policy choice on accounting for such credits
in determining whether to include them in the numerator when assessing the
substantially all condition. See Deloitte’s Roadmap Income Taxes for additional
guidance on the policy elections an investor can make regarding the accounting
treatment of transferable income tax credits.
The evaluation of the substantially all condition should be determined on a
discounted basis by using a discount rate that is consistent with the cash flow
assumptions used by the investor when deciding to invest in the project. As
noted in paragraph BC19 of ASU 2023-02:
The Task Force also determined that the substantially all test must be
calculated using discounted amounts because generally when making an
investment, the tax equity investor is not considering the cash to be
received upon exiting the structure as a significant factor for entering
into the investment and because the approach is also consistent with
other areas of GAAP in which future cash flows are considered.
Therefore, Task Force members viewed cash flows that occur later in the
project’s life as not weighing as heavily on an entity’s investment
decision and, therefore, determined that discounting the amounts was
appropriate.
Although the term “substantially all” is not defined in the
Codification, we believe that a ratio of 90 percent should generally be used to
determine whether the income tax credits and other income tax benefits generated
by an investee meet the substantially all threshold. However, if an investor has
previously established an accounting policy to quantify substantially all (e.g.,
a policy established during the implementation of ASC 842 to evaluate lease
classification), that existing policy should continue to be used.
D.3.3.1 Confidence Interval Used in Modeling the Projected Benefits of an Investment
When evaluating whether to invest in a tax equity structure,
investors will often model the projected income tax credits, other income
tax benefits, and non–income tax benefits expected to be generated by the
underlying project. If the investor ultimately invests in the tax equity
structure, this modeling is commonly used in the assessment of whether the
investment qualifies for the proportional amortization method. For some
types of tax equity structures (e.g., on-shore wind PTC structures), the
modeling may be performed on the basis of third-party studies that predict
how much production the project will generate, which is directly related to
the amount of tax credits to be generated by the project. The studies
usually include a “confidence interval” that indicates how likely it is that
a specific level of production will be reached. Questions have arisen about
what level of probability (e.g., p50, p75) is required in such studies for
the modeling to be used to assess whether the investment qualifies for the
proportional amortization method.
Modeling with a 50 percent confidence interval (i.e., p50)
reflects the median income tax credits and other income tax benefits that
are expected to be generated by the project. Said differently, in half of
the periods included in the model, actual results are expected to exceed the
p50 level results, and in the other half of the periods modeled, actual
results are expected to be below the modeled results. We understand that in
practice, modeling is performed by many sponsors and tax equity investors at
the p50 confidence level, which is meant to reflect the “best estimate” of
tax credits expected to be generated when making an investment decision. We
believe that it would be appropriate for a tax equity investor to apply the
same confidence interval used in making its investment decision to determine
whether the investment qualifies for the proportional amortization method.
As a result, we believe that modeling at the p50 confidence level is
sufficiently precise for assessing whether a tax equity investment qualifies
to be accounted for by using the proportional amortization method if that is
the confidence level used by the tax equity investor in making the
investment decision.
D.3.4 Positive Projected Yield
Under the fourth scope criterion that must be met for an
investor to elect to use the proportional amortization method, the investor’s
projected yield, calculated solely on the basis of the cash flows from the
income tax credits and other net income tax benefits, is positive. When
evaluating this criterion, an investor should consider income tax credits as
well as other net income tax benefits expected to be realized from the
investment. such as net operating losses. In a manner similar to the
substantially all criterion discussed above, this positive projected yield
criterion should be evaluated only on the basis of (1) income tax credits within
the scope of ASC 740 and (2) other income tax benefits, net of income tax
expenses (if any). If an income tax credit is not eligible to be included in the
substantially all criterion, it should similarly not be included in the
evaluation of whether the investment has a positive projected yield. See
Section D.3.3
for additional guidance.
D.3.5 Form of the Investment
Under the fifth and final scope criterion that must be met for
an investor to elect to use the proportional amortization method, the investor
must be a limited liability investor in a limited liability entity for both
legal and tax purposes, and the investor’s liability must be limited to its
capital investment. In practice, investments made through both partnership and
LLC structures meet this scope requirement.
Questions have arisen about deficit restoration obligations
(DROs) and whether the inclusion of a DRO in the investment agreement would
preclude an investment from qualifying for the proportional amortization method.
Some believe that an investor’s liability may not be limited to its capital
investment if a DRO is present. DROs serve to restore either the investor’s or
the sponsor’s tax capital accounts if they fall below zero. This is often
achieved by performing an additional step in the calculation of the earnings to
be allocated to the investor and sponsor each period; the requirement for the
step is only triggered if the investor or sponsor has a deficit in its tax
capital account that would result in the contribution of additional capital by
the tax equity investor only upon a formal liquidation. A DRO is not the same as
an obligation to fund the operating losses of an investee since it would only
result in a loss upon liquidation and therefore would not preclude an investment
from qualifying for the proportional amortization method.