Federal investment tax credits (ITCs) are government-endorsed, social-engineering tools designed to create a “partnership” between the government and the private sector, providing financial incentives to encourage corporations to deploy capital investments in areas that are considered important or strategic for the country. These areas include affordable housing, new market development, historic rehabilitation and renewable energy among many others. The government is simply not in the business of, or does not have the capacity to, properly assess the risk and evaluate these types of projects, so it turns to the private sector to lead the charge and recognize the opportunity presented the financial, social and environmental benefits of investment tax credits.
All companies that are U.S. federal taxpayers should consider tax credit investing. Banks and insurance companies are the most common players to-date, and while corporations have become more active in recent years, tax investing overall remains underutilized.
It is estimated that only a short list (less than 10%) of the qualified tax paying companies actively participate in the ~$20 billion annual tax credit market. This low participation rate has resulted in billions of “less than efficient” income tax payments to the U.S. government that could have otherwise generated value for companies, shareholders, and communities. Given the large number of mature, cash-flowing companies in the US seeking earnings enhancements, cash or tax management improvements and lower expense ratios, these are eye-opening statistics.
So why are tax credits not more widely used by corporate America? While there may not be a clear-cut answer to this inquiry (or perhaps it is a combination of factors), here are some possible, common explanations:
Too Good to be True – When companies first learn about tax credits, they think they are “too good to be true,” and that they must be some kind of scheme or loophole. According to the eminent psychologist and economist, Danny Kahneman, human nature is to avoid risk and loss, and therefore our first instinct is to play it safe and “pass” on the opportunity
Lack of Transparency – In reality, disclosures in the tax credit space are limited and the market tends to be unclear at times. Unless you are one of the few large corporates taking advantage of these programs or have engaged a top tax law or accounting firm, there is very little information available on how successful these tax credit programs actually are. This is probably one of the most significant hurdles to making their use more widespread.
Industry Competition – Tied to the above reason, perhaps companies reaping the benefits of tax credits prefer to keep it on the “down low” since they provide a competitive advantage and do not want their competitors to find out about their corporate tax strategies.
Public Misperception – Companies may also keep away from tax credit strategies because of how they may be perceived by their customers. The average person hears the words “tax credit” and immediately ties it to “tax forgiveness” without understanding that it is repurposing of tax dollars. The company doesn’t get away with NOT paying its taxes, it is simply given the option to direct those tax dollars to causes that benefit us environmentally and socially.
C-Suite Battle for Attention – Senior level executives in all companies are busier than ever. Many times, they simply are not aware these tax credit programs exist and if they do, (a) they have a vague idea of what they are; (b) do not have the time to understand; or (c) their knowledge is outdated. According to CFO.com’s Kathy Hoffelder, the “C-suite doesn’t know enough about what tax incentives are available on the federal, state and local levels. The heads of corporate tax departments are traditionally the keepers of such information, and ‘there is a big gap’ between what the tax executives know about the incentives and what the C-suite know.”
Lack of Innovation – Corporate cultures and incentives (or lack thereof) can sometimes stymie innovation. Most companies suffer from “organizational inertia”, in which the desire to seek and develop new solutions is often tempered by the stronger desire to not disrupt the status quo. It is rare to find tax executives who are encouraged to proactively find yield opportunities that can generate millions for the company while having positive secondary impacts on communities or the environment. Additionally, and in their defense, seeing their work loads and keeping up with the changing tax code, they just do not have adequate time to explore innovative tax strategies, unless mandated from above. So sadly, in many cases, even the tax executives themselves may not be aware renewable energy tax credits exist or how they work in practice.
Skeleton Crews – The reality is that many companies do not have the bandwidth or capacity to dedicate to executing tax credit strategies. Companies nowadays almost always run on a skeleton or near-skeleton crew. As a result, all members of the team are busier than ever trying to maintain growth, remain competitive, expand markets, and face old and new threats and risks. All hands are on deck, and they are all multi-tasking. Adding dedicated headcount in the tax department to pursue a new opportunity is a hard sell, and one person alone is simply not enough. To successfully access and benefit from tax credits, you need a team to manage the entire process, including origination, analysis, underwriting, and asset management.
Markets Don’t Care – Lastly, tax credits may be overlooked and underused by corporations because Wall Street analysts and the market do not seem to care and/or pay much attention to them. This is likely to change for several reasons. First, under the prevailing inflationary environment, the profitability of U.S. corporations will likely face downward pressure, driven by margin compression and weaker demand. Concurrently, companies are under increasing pressure from their stakeholders to make environmentally responsible investments that will get them closer to net-zero. Climate change and ESG (environmental, social and governance) investing have already become key themes in quarterly earning calls, a trend that is expected to continue. Analysts will have start paying more attention to what corporations are doing with respect to their tax strategies and how these impact their financial and non-financial goals in order to identify and reward companies that are doing the right thing, the right way.
Tax credit investing is complex, requiring careful analysis and in-depth understanding of the tax code as well as financial, accounting and legal concepts. Employing tax credits requires attention to the strict criteria that must be met in order to remain within the “safe harbor” requirements and avoid recapture risk. These large scale projects demand top-tier developers and EPC firms to design, build and maintain them, as well as conduct in-depth and thorough due diligence. This is why a strong and knowledgeable internal team or a partnership with an external, reputable tax specialist is needed and highly recommended.
Whether you are a CFO, Treasurer, Tax Director, ESG Director, Sustainability Officer, Portfolio Manager or Equity Analyst, we hope this document has piqued your interest enough to look further into investment tax credits. In the end, these government approved and encouraged tools go well beyond ordinary tax deductions and expense offsets (like R&D Credits). Investment Tax Credits are quasi capital investments that become productive assets on a company’s balance sheet and they also help strengthen environmental and sustainability strategies.
After a full analysis companies may decide that ITCs do not apply to or are not useful for their organization; after all, tax credits are not for everyone. That said, in the event your company decides to access the investment tax credit program, it is almost certain it will become a repeat user. Interestingly, some repeat users of ITCs also happen to be some of the most successful and highly valued corporations in the market.
Contact a member of our team today to learn more about how you can get involved.
Read more insights into the financial and ESG benefits of ITC investing by Alejandro Santa Cruz here.