Maximizing financial benefits of investment tax allowances in renewable energy portfolios

ABSTRACT

Policy makers offer fiscal incentives to encourage companies to invest in renewable technologies. This work considers generation companies that take advantage of fiscal incentives to minimize income tax. Thus, a novel mixed-integer linear optimization model that minimizes total tax payments of a company owning a portfolio of energy projects is designed. The model strategically manages depreciation, tax loss carryforward, and tax incentive use for minimizing discounted income tax. A set of revenue scenarios was employed to analyze model results. The proposed model yields tax savings between 8.2% and 19.2% of the company’s taxes. Tax savings are significantly larger for companies with a large generation portfolio; which represents a clear advantage over small generation companies. The proposed model can also be employed by policy makers to adjust future ITA policies by taking advantage of the anticipative knowledge of the optimal tax strategies implemented by generation companies.

KEYWORDS:

• Depreciation
• tax optimization
• investment tax allowances
• tax loss carryforward
• renewable energy investments
• mixed integer linear programming

Acknowledgements

The authors gratefully acknowledge the financial support provided by the Colombia Scientific Program within the framework of the call Ecosistema Científico (Contract No. FP44842-218-2018). We also thank the anonymous reviewers for their constructive comments.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Nomenclature

Sets:
$\mathrm{\Psi }$	=	Generation project set.
${\mathrm{\Psi }}^R$	=	Renewable project set.
${\mathrm{\Psi }}^{NR}$	=	Nonrenewable project set.
$\mathcal{T}$	=	Year set.

Indexes

$p$	=	Denotes project $\rho \in \mathrm{\Psi }$.
$t$	=	Denotes year $t\in \mathcal{T}$.

Parameters

$C_p$	=	Nominal power capacity of project $p$ (MW).
$I_p$	=	Investment cost of project $p$ ($/MW).
$f_{p,t}$	=	Fixed O&M cost of project $p$ in year $t$ ($/MW-yr).
$c_{p,t}$	=	Variable O&M cost of project $p$ in year $t$ ($/MWh).
$v_{p,t}$	=	Total O&M cost of project $p$ in year $t$ ($/MW-yr).
$e_t$	=	Estimated total energy production in year $t$ (MWh).
${\rho }_p$	=	Annual capacity factor of project $p$ (%).
$x_{p,t}$	=	Degradation state of project $p$ in year $t$ (%).
$D{R}_p$	=	Degradation rate of project $p$ (%).
$R_t$	=	Annual revenues of year $t$ ($).
${\pi }^{\mathrm{m}}$	=	Market price ($/MWh).
${\pi }^{\mathrm{c}}$	=	Contract price ($/MWh).
${\eta }_t^{\mathrm{c}}$	=	Fraction of the contract prices (dimensionless).
${\eta }_t^{\mathrm{m}}$	=	Fraction of the market prices (dimensionless).
$a_{p,t}$	=	Effective hours project $p$ operates at full capacity in year $t$ (h).
$T^{\mathrm{I}\mathrm{T}\mathrm{A}}$	=	Period in which ITA applies (yr).
$y_t^{\mathrm{p}\mathrm{r}\mathrm{e}\mathrm{l}}$	=	Taxable income in year $t$ before ITA ($).
$NPV$	=	Net present value ($)
$\alpha$	=	Annual corporate tax rate (%).
$\beta$	=	Maximum allowable ITA (%).
$\mu$	=	Income-based annual ITA upper bound (%).
$d_{p,t}^{\mathrm{m}\mathrm{a}\mathrm{x}}$	=	Maximum allowable depreciation of project $p$ in year $t$ (%).
$r$	=	Discount rate (%).
$\gamma$	=	Discount factor (dimensionless).
$M$	=	Big number ($).

Decision variables

$i_t$	=	Percentage of ITA taken in year $t$ (%).
$y_t$	=	ITA-affected taxable income in year $t$ ($).
$d_{p,t}$	=	Depreciation rate of project $p$ in year $t$ (%).
$z_t$	=	Tax payment in year $t$ ($).
$w_t$	=	Tax obligation in year $t$ ($).
$s_t$	=	Tax loss in year $t$($).
$IT$	=	Present value of income tax ($).
$u_t$	=	Binary variable (dimensionless).

Additional information

Funding

The work was supported by the Colombia Scientific Program within the framework of the call Ecosistema Científico (Contract No. FP44842-218-2018).