Recent Tax Developments around Renewables

The renewables sector has undergone rapid change in recent years. During the pandemic, many countries tried to boost their economies through strong tax and financial incentives for energy efficiency works and the use of renewables in the private sector.

Now the pandemic has ended, factors including the rising cost of raw materials, difficulties in supplying the materials essential for the use of renewables, inflation with high interest rates on public debt and bonds and strong variability in the cost of energy have contributed to a significant contraction in the financial resources allocated to the renewables sector, and consequently a substantial change in the type of investments.

Large Investments and Key Tax Topics

The scaling back of incentives has pushed investments towards larger projects (e.g. photovoltaic and wind power) to achieve sufficient margins in the absence of tax breaks.

Special Purpose Vehicles (SPVs)

In almost all European jurisdictions, investments related to renewable energy projects are usually realised by means of the incorporation of non-transparent entities, corporations or limited liability companies. Regardless of whether these are held by resident or foreign investors, special purpose vehicles (SPVs) have only one purpose – to generate energy from renewable sources – and so are set up specifically to undertake individual projects that meet regulatory requirements and benefit from limited liability. SPVs are subject to all the local tax rules, but can also better exploit local incentives.

Derivative Contracts

Large projects, in combination with the dynamics of energy pricing, have seen the emergence of derivative contracts – among them, so-called power purchase agreements (PPAs) – that settle differentials linked to changes in the price of electricity. The fiscal nature of these derivatives is of fundamental importance because they can be configured as contracts for the sale of energy or, as in Italy for example, as purely financial contracts. In the latter case, the financial nature of such derivatives has led to their exemption from VAT, with disadvantages in terms of VAT deduction on purchases due to the pro-rata deduction.

Real Estate Relevance

The large size of parks required, especially for solar panels, has increased concerns regarding whether the asset to produce renewable energy is considered of a real estate nature.

In this regard, according to the provisions of several countries (e.g. Spain and Italy), upon disposal of the shares of a specific SPV by a non-resident investor, a taxable capital gain could arise if the asset value of the SPV is mainly composed, directly or indirectly (i.e. more than 50%), by real estate located in the respective territory.

Therefore, in structuring these investments, it is increasingly important to consider capital gains tax on the disinvestments of these projects in light of local tax rules and of provisions of the applicable tax treaty.

Cash Trapped

Further key issues that investors should consider when structuring their investments (and return expectancy) in any European jurisdiction are accounting and tax depreciation rates and the criteria applicable to real estate assets devoted to the production of renewable energy. Cash trap issues should be considered when establishing the depreciation criteria to be followed on a linear basis (i.e. a fixed rate over the asset’s lifetime), since they may not be changed afterwards.

In Spain, for example, tax-deductible depreciation rates for renewable energy plants (e.g. photovoltaic installations) can go up to a maximum annual rate of 7%, resulting in a depreciation period of almost 15 years minimum and 30 years maximum.

Since the registered depreciation expenses would directly impact on the SPV’s profit, and therefore on its distributable reserves, it is highly advisable that investors review their financial models (cash forecast and upstream flows expectancy) before determining the linear tax depreciation rate.

Taxes must be included in financial models. In France, for example, there are specific local taxes applicable to renewables installations. In addition to real estate tax (taxe foncière), the operations of these facilities are subject to various other local taxes (CFE, CVAE and IFER), all of which can have a significant impact.

Tax Incentives in Europe – Uneven Tax Policies

Each European country has developed its own tax incentive policies for budgetary as well as political reasons.

Spain still pursues a strong incentive policy. In fact, to encourage the development of renewable energy projects, tax reliefs amounting up to 90% of the Works, Construction and Instalment Tax (accrued as per the construction of real estate assets devoted to the production of energy) are usually established for construction or installations works in which systems for the thermal or electrical utilisation of solar energy are incorporated. In addition, in respect of Real Estate Tax (which is also a local burden), many municipalities have introduced reduced tax rates and tax reliefs applicable to the corresponding quotas to real estate assets devoted to the production of energy.

France is currently contemplating the introduction of a specific tax credit for green industries (e.g. battery production, solar panels and wind turbines) within the EU, upon the French authorities’ prior approval of a project’s eligibility. Such tax credits will be notified to the EU commission (state aid).

In contrast, Italy has abandoned a 110% tax credit for expenses incurred for energy efficiency and the use of renewables.