In this episode of Clean Incentives, host Brendan Sigalet speaks with Jeremy Matthies, a tax insurance specialist at CAC Specialty, about how tax insurance is becoming a critical tool for clean energy project developers and investors in Canada. They explore how tax insurance helps mitigate risks associated with investment tax credits, including Canada Revenue Agency reassessments, compliance with labour requirements, partnership structures and tax shelter rules. Drawing on lessons from the US market, they break down how tax insurance can improve project bankability, reduce uncertainty and unlock capital for renewable energy, carbon capture, and other clean economy initiatives.
Transcript
Jeremy Matthies: [00:00:00] If you've built a $50 million ITC into your project and that doesn't happen, do you still have a project? Is this dependent on getting that ITC is your payback period? Is it important for you to get that ITC within a certain amount of time? So those are all things that right now what I'm seeing is it's getting lenders comfortable, and lenders are quite happy to know that a client is going to be able to ensure those ITCs and guarantee that they're, the bank is not going to be out of pocket if the ITC doesn't come to fruition.
Brendan Sigalet: [00:00:41] Welcome to Clean Incentives, a podcast series within the Bennett Jones Business Law Talks podcast that discusses topics around taxation incentives for developing clean technology projects in Canada. I'm Brendan Sigalet, tax associate at Bennett Jones, LLP, and my practice focuses on the tax aspects of energy transition deals, including renewable energy, carbon capture, and hydrogen projects.
Before we begin this podcast, please note that anything said or discussed on this podcast does not constitute legal advice. Always seek proper advice from your legal advisor as every situation is different and outcomes can vary.
Today we're discussing a critical topic for businesses and investors looking to capitalize on Canada's clean economy investment tax insurance, investment tax credits, or ITCs play a vital role in incentivizing clean energy projects across Canada. However, like any tax-based incentive, there is an inherent uncertainty, whether it's related to eligibility, compliance or potential reassessments by tax authorities.
This is where tax insurance comes in, offering companies a way to de-risk their projects and ensure that they receive the full financial benefits that they expect. To help us look at this complex but increasingly essential tool. We're joined by Jeremy Matthies, tax Insurance specialist at CAC Specialty, an insurance brokerage and advisor that provides expertise in placement capabilities across the spectrum of insurance and capital markets.
Jeremy has been at the forefront of structuring insurance solutions for companies navigating the evolving tax landscape, particularly for projects relying on clean economy, ITCs. On this episode we'll explore the history of tax insurance and how it developed in Canada, how tax insurance has been applied in the US for clean economy ITCs, and what Canadian businesses need to know about securing tax insurance for their projects and key considerations around structure tax shelters in the general anti avoidance rule or gaar.
Jeremy, welcome to the podcast.
Jeremy Matthies: [00:02:43] Thanks for having me.
Brendan Sigalet: [00:02:44] So, just to start our discussion today, just kind of want to set the stage with respect to some tax insurance basics. Can you start by giving us a quick overview of what tax insurance is and how it works?
Jeremy Matthies: [00:02:57] I can, yep. Thanks. So generally, tax insurance has been around for 15 years.
It's probably been more prevalent in Canada in the last five. Generally, I would say the purpose is to crystallize a future looking tax risk, knowing that. Risks with the CRA after you make a tax filing tend to have a long tail on them. There can be a seven-year statute of limitations on how long they can take to reassess a tax filing.
And lots of businesses look at that risk and you know, that can cause problems in M&A for indemnities. You want to give their long life and their unknown quantum, you know, you're closing out a private equity fund and you're sitting on capital because you may have to escrow it pending, what will CRA do down the road, as sort of a couple of examples.
So, I think really just crystallizing a tax risk so that you can move on with your business. Redeploy capital. Close out a fund. Close a transaction. Is kind of what the main purposes of the product are.
Brendan Sigalet: [00:04:03] And you mentioned kind of M&A, is that generally where, you know, tax insurance started in Canada? How has it evolved historically?
Jeremy Matthies: [00:04:10] Yeah, I think tax insurance, much like rep and warranty insurance, which, many folks are probably more familiar with, started through private equity firms needing a new vehicle to avoid typical holdbacks on M&A transactions, or escrow and M&A transactions. So, in the rep and warranty con sort of construct, they were looking for ways to make it easier for the seller to get a deal done and get their capital in their pocket.
Similarly, for tax, if you look at it from a, it started with private equity saying, look, we've got a due diligence bust and an M&A deal. We're going to need some way to allow this deal to move forward so that the buyer doesn't take on a budget tax risk, and so that the seller doesn't have to give a big indemnity or escrow a bunch of funds for a long period of time.
And insurance stepped in and said, we can cover that risk. If it's reasonable, we will allow you to do away with your escrow. And the buyer can rely on insurance to pay if this tax bust comes to fruition.
So, at the end of the day, a big insurance carrier comes in and says, you have the potential of a $10 million tax problem. The seller doesn't think it's a problem. The buyer thinks it is, it may never come to fruition, but if it does, we can pay out the $10 million after receiving some premium, of course, and the buyer can walk away whole, and the seller doesn't have to give a big indemnity. So, it's really, that's sort of the nexus of it came from M&A.
And it's become now a product that's evolved into many other things.
Brendan Sigalet: [00:05:47] And so, what kind of tax risks do companies typically seek to insure in the M&A context? You know, I understand, you know, sort of some non-resident withholding issues, that sort of thing. You know what, what else is typical out there in that context?
Jeremy Matthies: [00:06:04] Yeah, absolutely. Like taxable Canadian property is a big one. It's probably been the most prevalent over the last five years. Obviously capital versus income is a big risk for folks that, because the delta and what you have to pay for capital gains tax versus income tax. But we've seen it creeping into other areas for sure, like safe income.
We've got, you know, transfer pricing can now be covered, which never used to be able to be covered. So that's been huge on sort of the international scene, VAT tax sort of vats across international. Sort of cross-border businesses and valuations, which, you know, you have a private company, you're valuing some shares that you're disposing of, for example, you'll typically get a range of valuation metrics from an accounting firm, and you're going to choose which of those to pay tax on.
Typically, you couldn't ensure that Delta, and now insurance companies are looking at those valuation metrics as they relate to tax. So, it's expanded. I like to tell clients, if you can get an opinion from a law firm, we can usually get you coverage.
So, if your legal counsel can tell you, at Bennett Jones, I think I can opine on this. Even though it's never been covered before, it doesn't mean you can't get coverage. All of these tax underwriters are lawyers. I'm a lawyer. Our whole team are lawyers, so everyone kind of has a good sense of what the risk proposition is when they see a should level tax opinion.
The market is very open to covering things they haven't looked at before.
Brendan Sigalet: [00:07:37] Interesting. I actually wasn't aware that you could cover valuation as well, and I hadn't heard of that one. It makes sense, I suppose if you're, you know.
Jeremy Matthies: [00:07:44] Yeah, I've had those shut down before in the past. You know, a client comes and says, we were, they were continuing out of Canada and it was a sort of a billion dollar valuation, but it was $200 million either side of that billion, and they wanted to pick the lowest number to have tax attributed to, obviously an underwriter's not going to say, well, let's cover you in just in case it's the top number in the valuation.
But now with enough homework and enough diligence and a client picking a reasonable price point in the middle, we can potentially get tax coverage for that delta from something reasonable to the top. If that makes sense.
Brendan Sigalet: [00:08:23] Interesting. Yeah, no, it seems kind of a more of a factual, you know, scenario, situation that they're covering there.
Jeremy Matthies: [00:08:31] That's with any kind of insurance, right? Like it starts off in a very narrow band, and then as underwriters and carriers get more comfortable with the product and they start, you know, generating more revenue, they start expanding the scope, right? And the scope kind of creeps into other areas that maybe weren't traditionally there.
But if they can get their head around it, they'll look at it and always starts with, you know, the most conservative players or the last entrance, right? But you can find sometimes there's new entrants, there's MGAs, which are managed general agents for underwriters, or sorry for carriers. So, if you have Liberty and Chubb and AIG, that's their money that they're, they're usually the most conservative.
But these MGAs groups that other insurers, like Zurich and Lloyd's say, hey, go place this tax insurance for us. You understand it better than we do. We trust you, we'll give you the capacity. And they're usually the leading edge of new products because that's all they do is they place tax or they place reps.
So as opposed to also doing home and auto and D&O, they don't focus on that stuff. So, they have a little better sense. They've got in-house lawyers, they're looking at these products going, I think we can move onto these other areas. Right. So that's kind of how it evolves.
Brendan Sigalet: [00:09:52] Mm-hmm. I think that makes sense. And so, there's kind of a whole marketplace of different players. Some of them are going to be a little bit more conservative and then some of are a little bit more willing to take on the risk and kind of enter into these new markets.
Jeremy Matthies: [00:10:07] Right. And I mean, obviously, we'll, we'll be transparent with clients about who those markets are and, but I mean, we're never going put a policy in place with, you know, a underwriter who's not a rated, for example. So, there's 30-some-odd underwriters doing tax insurance in the us. A dozen of those will cover Canada.
There's another, you know, dozen in the UK that'll participate in Canada and the US. So, the scope is very broad. So, if you go to the market and you seek quotes from 35 different carriers, you might get quotes from two or you might get quotes from 20, but usually you can find a home for it.
Brendan Sigalet: [00:10:46] You mentioned the US and the UK. Is that where this market kind of developed with respect to tax insurance generally and is that why there's more players in those spaces?
Jeremy Matthies: [00:10:56] Yeah, absolutely. I mean, most insurances stem from rom Lloyd's and starts in and moves its way into the market. The US has, I would say, been pitching, US brokers have been pitching tax insurance for 10 years.
I've been doing this for, this is the start of my fourth year in Canada, but in the last three years, tax insurance in the US has gone sort of parabolic. It's being used in the ordinary course by Fortune five companies six times a year. They'll take out policies on all kinds of international risks, on domestic risks, you know, state tax, anything you they can think of that they can get coverage for, they're now willing to take that off their balance sheet and foist it onto an insurance carrier.
That hasn't happened yet in Canada, but you know, we typically trail sort of that capital movement in the US by a few years, and I think we're getting there and our businesses here are a little more open to saying, look, even though I'm a large company and I have a deep balance sheet, I have lots of cash on hand.
I don't necessarily need to self-insure, right? If I'm going to self-insure, I need $50 million set aside for that possibility that there could be a tax issue. Why wouldn't I pay a premium, move that $50 million off balance sheet to an insurance company and redeploy my capital somewhere else? So, I think the market has really evolved in the US and hopefully we'll get there in the, in Canada where it's not just a sort of one-off product, it's something that companies are now putting in their toolkit and using it quite often.
Brendan Sigalet: [00:12:34] And so tax insurance hasn't quite caught up in Canada to the place where it's in the US There's still, you know, some of the bigger companies are still self-insuring, but do you expect that they will follow the trend, the cattle led by the US and you know, so the bigger companies will, will start to kind of look at this and born the ordinary course?
Jeremy Matthies: [00:12:53] I think so. I mean, it makes sense. It's obviously, I mean, tax insurance is industry agnostic, but there's certain industries where it's going make more sense, right? Like if you're doing work internationally, if you've got retail or you've got sales tax issues, there's going to be different industries where there's going to be more components of tax that are in play, for example, and upstream oil and gas company might have.
Brendan Sigalet: [00:13:24] Yeah, I think that makes sense. With respect to, you mentioned some of the industries that are kind of typically relying on this, it sounds like it's more kind of international businesses that, you know, might have more complicated tax structures. And are there some industries where this is, you know, historically have taken advantage of tax insurance more than others?
Or is it kind of industry agnostic and more dependent on the particular structure of the business in question?
Jeremy Matthies: [00:13:50] Yeah, I think it's more the latter. I don't think you could just pinpoint and say these are the industries that use it. I mean, tech businesses use it, retail uses it. Obviously renewable energy businesses use it.
So, there are certain instances where oil and gas businesses will use it. Mining businesses, so it's, and it's also a bit a good product for transactions because obviously if you have a due diligence problem with tax on an M&A transaction, which was entirely industry agnostic, your rep and warranty insurance, if you were going down that path, wouldn't cover a known issue.
So, as soon as you find a problem in due diligence, when you're buying a business, that buyer is relying on rep warranty insurance. If they find a bust in the tax due diligence, it's now kicked out of your rip and warranty policy. So now you're pivoting going, well, we need something to help us cover off this, this gap for tax. It could be tax insurance.
So, I'd say, you know, it's valuable for any industry, and it depends on the scenario, but to your point. We get calls on things that we'd never considered being something we'd insure. We take the advice from the law firm, and we go to the market and they're like, yeah, we think this can be covered.
This makes sense, right? It has to be, the risk has to be reasonable enough, like the product isn't for something that's a coin flip. It's got to be sort of in that 25% risk, 75% certainty, which is sort of your should level, should level opinion, kind of comfort. But I would say every industry should know it exists and then their tax team or their in-house team will have a good sense of where, where are my risk?
We see lots of real estate businesses looking at this right now, saying, you know, I've got developments, I've got raw land. There are certain things I'm looking at. Maybe, maybe my tax filing position can get. Insulated by some insurance and I can redeploy the capital on my next project.
Brendan Sigalet: [00:15:54] Certainly, I think that, you know, within our firm, definitely, and it seems like across kind of the spectrum of tax lawyers in Canada, this is, you know, we're increasingly looking at, you know, tax insurance as an option.
Whereas, you know, 10 years ago it wasn't really something that was considered. Speaking. You know, turning to the, with respect to, you mentioned the clean energy space. A lot of what we're, you know, the clean economy ITCs were a direct response to the clean energy incentives in the IRA in the states.
And so, a lot of the trends that we're kind of seeing, we first see occur down there, um, because they had their legislation passed before us. Four ITCs that were, were just passed in June last year. So, I understand we've seen tax insurance playing a growing role with respect to the US clean energy sector.
Can you walk us through how it's been applied to ITCs in the US?
Jeremy Matthies: [00:16:50] Yeah. I think it's important to be cautious when comparing the US renewable space to the Canadian space. I mean, the businesses are the same, obviously, when, when project solar projects, they don't change based on what country you're in. But in Canada we have a refund system. In the US they do have a direct basis, and it started off as payment and now it's more of a credit. And the IRA when it was put in place now allows you to trade those credits, and that's really been the uptick on insurance in the us.
So, for example, a company's building a wind project is going to come into some ITCs, but they're not really that valuable to that business because they're not going to have taxable income for a long time.
So, they can't really make use of those credits. What they can do is monetize them by transferring them or selling them to a buyer who says, I'm taxable now. I'd love to have those credits. I'll pay you 90 cents on the dollar for all these, and that 10 cents a savings on my tax bill make sense to me? If I can accumulate enough of these.
So, on all those transactions, or most of those transactions, that buyer will mandate that there's insurance from the seller's perspective to backstop those ITCs in case there's a bus or case there is something that it turns out maybe that. Project developer wasn't entitled to those ITCs. So it's another level of due diligence, another level of security for that buyer to say, when I get these, I'm going to apply them against my taxable income and in the event that there's a breakdown and I don't get to use them and the IRS says, sorry, you bought something that wasn't valid, insurance will step in and gimme that money and I'll be kept whole.
So, I would say roughly 50% of the US tax insurance market right now is those credit transfer policies that are backstopping a market that's gone incredibly wild. You know, we're doing 15 of these at any one time. And if you took those out of the market entirely, you'd see a much, you know, sort of smaller tax market.
But it's been great because it's introducing all these clients to the product and then they're saying, wow, is there other places I can use this product because this is pretty seamless on my ITC deal. So, it's really taken the US market and, and sort of exponentially doubled it in the last sort of three or four years, or three years for sure.
Brendan Sigalet: [00:19:30] Yeah. A can you walk us through exactly how that, how that works in the US market? Because I, you know, so the tax, the particular corporation that's building a project gets the ITC and then they sell it to, you know, a third party and in order to sell it, they have to have it insured.
And, but there's kind of ongoing requirements that they have to meet in order to con to generate those ITCs. Right?
And understanding you're not a US expert in respect of, you know, the IRA, the production tax credit system they have down there. But you know, they have labor requirements down there, for example, which are kind of ongoing requirements that have to be met by the particular, you know, project proponent.
So how does it work that you know that they can get tax insurance when there's kind of ongoing requirements by the project proponent, which is kind of wiped its hands of the deal, sort of thing, when they sell the ITC.
Jeremy Matthies: [00:20:33] In the US carriers will ensure prevailing wage and apprenticeship compliance, the US equivalent of our labor requirements during the five-year recapture period, subject to an exclusion for non-compliance.
However, that exclusion will not apply, i.e., the policy will not apply to any failure to satisfy the prevailing wage and apprenticeship requirements. If that work was completed pursuant to a contract with an EPC and engineering procurement construction company, or a third-party service provider that was under contract, assuming that contract was reviewed by the underwriter, consented to by the underwriter or contained provisions substantially similar to those that the underwriter reviewed.
So, in short. The answer is labor requirements can be covered, but a contract with a reputable third-party EPC that's in place at the time of underwriting will definitely allow us, the broker, to negotiate better policy terms.
Brendan Sigalet: [00:21:39] That's interesting that the US markets going develop to be comfortable with the long tail on these things as, as you mentioned, because obviously, you know, there are similarities in the Canadian context, not from the project proponent selling the ITCs, but the project proponent is, you know, claiming the ITC and then they have continuing obligations, whether it's labor requirements, recapture, claw back, those sort of things.
And potentially, you know, it's something we can point to and say, well, you know, they figured it out in the US. So, therefore, you know, potentially they might be able to figure it out here as well. Turn to that, you know, how does the Canadian market currently compare with respect to the clean economy ITCs? And what kind of risks are, you know, tax, insurance helping to mitigate for the clean economy ITCs in the Canadian context?
Jeremy Matthies: [00:22:34] Yeah, not to give the impression that the ITC market is entirely just credit transfers in the US there are opportunities to ensure ITCs that are future ITCs, much like Canada. There are direct pay opportunities. There's financing where you build a model in the US just like in Canada and you say, hey, here's how much of an ITC we're building into our model.
And if that doesn't come to fruition, the lender in that scenario might say, well, if there's a bust in your ITC, your model's kind of broken, how do we know that's going to happen? Right. So, in Canada, I think that's more the model. It's a lot of, are going to require lending and that lender's going to want to get comfortable with if you've built a $50 million ITC into your project and that doesn't happen, do you still have a project?
Is this dependent on getting that ITC, is your payback period, is it important for you to get that ITC within a certain amount of time? So those are all things that, right now what I'm seeing is, it's getting lenders comfortable and lenders are quite happy to know that a client is going to be able to insure those ITCs and guarantee that they're, the bank is not going to be out of pocket if the ITC doesn't come to fruition.
That being said, generally the projects that are going ahead, there doesn't seem to be a lot of lender sort of trepidation around, is this going to qualify or not? So, I think right now we're finding that the ITC risk that requires insurance is kind of few and far between at the moment. I think as the lending community grows and it becomes less just the big five sort of charter banks and other groups are looking at this, I think we'll see insurance become more and more prevalent.
If there's any questions, like really what we're ensuring is structure. So, if you have a unique structure or using a partnership instead of a corp, or you have any, because the rules require that you take your ITC in a corp. There are some questions around using limited partnerships. That's been sort of the normal course for fundraising.
So that can be insured. I'm doing that at the moment. Also, do you qualify for, you know, if you had a carbon capture project and you were looking at does all this equipment, capital costs qualify, qualification be, can be covered. Again, it's just, it's trying to find that sweet spot where there's risk, but it serves a purpose to get a lender over the line.
I've sat down with a very large carbon capture project client yesterday and they said, look, we don't need the insurance, but our partners in this project might because they're smaller than we are, they don't have our sort of capital to backstop this. It's something I would like you to pitch to me, so I can pitch it to them.
So, I think it'll expand, and it'll grow. But everything sort of seems down the fairway right now in a lot of these projects and there's not a lot of unique structuring being done because everyone's just trying to get in the door. And I think as projects grow and evolve, I think we'll see it becoming the insurance side becoming more prevalent. That's just, that's my soapbox stance on it
Brendan Sigalet: [00:26:03] No, I think that makes sense. I think that there's so many risks with respect to the clean economy ITCs, you mentioned, you know, the structuring aspect, uh, particularly in the limited partnership or partnership context. I think that that makes a lot of sense.
You know, any corporation who's planning to claim a clean economy ITC through a limited partnership, you know, you have the risk of, first of all, how much ITC are you taking out, so you have to ensure that you have sufficient at-risk amount of the corporation and limited partnership. And then, additionally, there's always the looming risk that, you know, a particular limited partnership interest might be considered a tax shelter investment.
Which in that case you have claw back of the entire ITC for the entire project in some cases. So, you know, that risk is obviously something that I would anticipate would be, you know, just table stakes. You need to have that insured. Is that kind of what you're seeing so far in the down-the-fairway deals, as you said?
Jeremy Matthies: [00:27:13] That's exactly what I'm seeing. So, I'm on my second deal that's covering reasonable allocation for the partnership, right. At risk amount, tax, shelter and gaar. So, all four prongs are being insured under one policy. If any one of those fours is named in an assessment or reassessment, the insurance will kick in.
Right. And in these deals, the one I've closed and the one I'm working on, it's really to backstop a bridge financing that clients said, look, I want, notionally, I have a $50 million ITC coming to me. I'd love for the bank to gimme that money now because I have two years of work to do and it'd be great to deploy that.
And the bank needs some sort of certainty. In some instances, there's nothing left to secure because the solar project or the wind farm has already been fully sort of secured on the main financing. When you get to the bridge, it looks a little skinny and they're kind of wondering, how are you going to pay this back if you don't get your ITC?
So, the insurance is a great way to get the bank comfortable, and the insurers have been okay to say, yeah, we'll cover gaar in this instance. It seems pretty low risk. We'll cover all those components that, you know, we've mentioned, tech, shelter. At risk amount, reasonable allocation. And we've, you know, received a strong opinion from the law firm on those files.
So, it's been, it's been doable, and I think that's going to continue to be the case. And I think as these projects get done and you know, people like yourself get more comfortable seeing more of them come across your desk, you know, even in these two deals we've seen a little bit of a pivot to more, I wouldn't say aggressive, but just some tweaks have been made to the structure because they feel more comfortable that, hey, you know, maybe our allocation can change here because we think we're okay.
So, I definitely see the structural piece continuing. And I think as there are just, it's, every lender's a little different. Some are very conservative, and they want everything covered off and buttoned down. Others are more flexible because they have to be, because, you know, they, that's how they get their business in the door.
So, we'll see what other unique structures we see. I wouldn't call these unique and they seem like very low risk prospects to me. But the banks want no risk. So, it's been a valuable tool.
Brendan Sigalet: [00:29:36] Yeah, and I think that, you know, from, from my perspective, having advised on some of these projects, you know, we've generally seen somewhat of a trend towards moving towards just incorporating a, a corporation and, you know, having that be the vehicle for the Clean Energy Project, precisely to head off the risk associated with the partnership structure.
But, as you know, we're drawing close to an election here and, you know, there's obviously different viewpoints as to what is going to happen with these clean economy ITCs. But one particular ITC that hasn't been enacted yet is the clean electricity ITC, and that particular ITC is available for tax exempt entities, particularly for First Nations groups.
And so, First Nations groups who are participating in these projects participate through a limited partnership structure historically. And the draft rules allow for the First Nation limited partner to a limited partnership to claim the clean electricity ITC on the same property that the taxable Canadian corporation claims, the clean technology ITC.
And so, I anticipate that, you know, we're going to be looking at a lot more of these limited partnership structures moving forward for these particular projects. And I think that, you know, having reviewed the rules in detail, I would not be comfortable using that structure unless you're getting tax insurance.
That being said, you know, you're talking about low amount of risk, but these rules haven't really been through the system yet. And so, I think that any project proponents should be just table stakes, should be getting tax insurance for the things that we talked about, tax and shelter investment, you know, reasonable allocation tests, at risk amount. But that's just my view on it.
Jeremy Matthies: [00:31:40] That's absolutely, what it just dovetails into something I should probably touch on because it would be important to the listeners. As more of those structures come into play, and, as you mentioned, none of these have really been vetted yet, right? Like CRA hasn't come back. We haven't seen assessments and reassessments on 25 of these yet. So, I know the first few are actually being filed, and I've talked to counsel has said, you know, I've actually got my returns in now the project's done.
So, to that point, I think it's important to know how these policies get diligenced is you write an opinion for your client, and I take it to the market. And the market then retains Canadian counsel other than yourself to review your memo and or your opinion and say, yeah, I think these guys have it right.
So really all we're doing is interpreting the law because we don't have a bunch of case law, we don't have a bunch of examples of audits being done and failing. But you can still get coverage. I think it's important to know it doesn't, this doesn't have to be, you know, 10 years of. Supreme Court case law for coverage to be implemented.
We just need the other side's counsel, the underwriter's counsel, to look and say that's a reasonable view that Bennett Jones has taken. I like it. I tend to agree. And the underwriter will then say, okay, let's get a policy in place. So even though it's new law, there's still legislation that we can lean on.
Reasonable allocation rule has lots of, you know, it's been around for a long time, so there's, we can sort of sift through that, get a good opinion on it, but the fact that this hasn't been litigated doesn't matter for the insurance purposes. I just want sort of point that out that it's going be available.
Brendan Sigalet: [00:33:30] Yeah, and I completely agree with you. I think that, you know, the that whole limited partnership question and, and tax insurance on structure, I think that, you know, that's just going to be, you know, like I said, table stakes. I think moving forward, until we get more clarity on how these rules are supposed to work.
I think that the interesting area will be in respect of things that haven't to date been insured in the Canadian context. And I think that, you know, the experience in the US can kind of give us some insight into things that haven't been insured yet, but that will become insurable. Particularly I'm thinking, you know, situations where, you know, you mentioned, you know, equipment eligibility for example, and, you know, we have some information as to what equipment's eligible.
There are some gray areas on the edges, and some of the eligibility question is factual in nature as to, you know, what is the intended purpose of this equipment? And it gets into kind of engineering in addition to the, the interpretation of the law. And I think that, you know, given that there's kind of this history in the US of dealing with those kind of factual situations and getting comfortable on those areas and you know, needing to deal with the Natural Resources Canada aspect, which, you know, they have to approve project plans and they're the ones who are ultimately going be tasked with determining what equipment's eligible and what isn't.
In addition to the CRA, I think that, you know, there, that might be an area where we'll increasingly see, you know, tax insurance for kind of those gray areas. And in addition, I think that, you know, with respect to even labor requirements, you know, they, if it seems that in the US they've been able to get comfortable on insuring those, is that right?
Jeremy Matthies: [00:35:30] Yep. I mean, obviously anything that's got that sort of forward looking or third-party reporting aspect to it is a little deeper dive on the underwriting due diligence side for sure. But I mean, what I touched on earlier on, transfer pricing, you're going to need a big report to get in front of underwriters to be able to demonstrate that you can ensure that valuation is factual.
You got an accounting report that you're looking at an evaluation very similarly. There are third parties now doing, you know, tracking labor requirements, monthly reporting to the client so that they can demonstrate we're on top of this. So as soon as those third parties get involved, that's always a deeper dive for underwriters.
But I do think having those third parties doesn't stop you from being able get a coverage because the underwriters now go out and they have their third-party vet, just like you would vet the opinion. They're saying, yeah, this report looks good. These guys have the structure in place. They've got the sort of, KPIs in place to make it's all tied down.
So, it doesn't stop you from getting the coverage. It's just an extra sort of hurdle you have to meet. But to your point, everyone's going to be sort of out there seeking these third-party groups to do their labor inducement review so they can stay on top of it because they want the money.
So, underwriters are used to that in the US and they're very excited to be into the Canadian ITC market. And we send our submissions out to the entire market in the US even though we know 50% of them don't participate in Canada. Because every time we go to the market and they're not allowed to participate, they go, okay, we need to start thinking about getting into Canada. Right?
So, it sort of encourages more participation in the Canadian market, which we have seen grow over the last three or four years. So, I think over time it's just going to become easier and easier for us to find a home for replacements as the Canadian market grows and more underwriters move here.
Brendan Sigalet: [00:37:37] I think that makes a lot of sense.
I think that as you have these third parties, whether it be labor requirements or you know, engineering firms with respect to technical aspects of these projects and whether or not equipment qualifies and compounding that with the, you know, the legal side of things to ensure that the legal test for, you know, whether it be the labor requirements and or the equipment eligibility.
For example, if you get an engineering report that says this is what this equipment does, then you compound that with a legal opinion saying that, you know, this is the test for what equipment's eligible and you put those together, then you have a pretty solid factual underpinning and legal basis that this equipment qualifies.
And you can take that to an underwriter, I would assume, and be able to, you know, get, get covered for, you know, something that maybe you otherwise wouldn't look to insure, at least at this stage.
Jeremy Matthies: [00:38:42] Really those third parties are just confirming the facts. Right? And to the extent facts are true, you don't have coverage in any insurance policy regardless of industry or regardless of type of insurance, right?
When you sign these policies up, you do sign a rep letter saying that to the best of our knowledge, everything we've provided is true. There are no misrepresentations. All our tax filings are consistent with what we've been telling you are going to be our future tax filing. So, I don't think that would be news to anyone in the business community that you know, to the extent you have a third party validating your facts that should allow you to open doors into the insurance space because it's not just you putting your hand on your heart, you've got an engineer saying, we agree. So, it shouldn't be an impediment.
Brendan Sigalet: [00:39:28] I think that makes sense. And I just see this area just, I just see it exploding over the next number of years as businesses start to grapple with, you know, the ability to, from a risk management perspective, to take that risk off the table and lenders get more comfortable with getting into this space and providing bridge financing and, and, and all the kind of things that we use project proponents without a massive balance sheet.
And even those with a massive balance sheet need to, you know, get these projects built. Just as you said, it's kind of an ability to redeploy capital, but otherwise you're sitting there with it just kind of sitting and self-insuring. So, I think it makes a lot of sense. So, you had mentioned kind of the factors that, you know, the underwriters consider when evaluating a policy for clean energy project.
You need the opinion from your legal counsel. What else do they typically require in order to, you know, place one of these policies?
Jeremy Matthies: [00:40:34] Well, really that's sort of the entry point as you get your legal opinion, we go to the market with that opinion. We solicit the market to see if we can find quotes, and once the quotes come in, you pick a carrier and you move forward.
The due diligence process from there would be, well, what did Bennett Jones review to get to this opinion point? So, if you have partnership agreements, limited partnership agreements, what is it that that ITC opinion is relying on. So, you're going to have to provide documentation. Everything's done under NDA.
We're happy to do common interest privilege letters to protect privilege for clients. But, at the end of the day, it is going to be a bit of a document dump that whatever you were provided with in order to get to your opinion, the other side's counsel's going to want to see as well. There's going to be a short 20-minute Q&A with the underwriter on what we call it, an underwriting call, where they're going to ask some questions about, you know, how's the project function if you don't have the ITC money? Can we see your model? So, can you show us how you've modeled this out? What does this look like? Because at the end of the day, if it's a bridge, for example, where are you financially? If this all goes according to plan, how much room do you have? How tight are you on debt? So, all the things the insurers are going to want to know.
So there is sort of a deeper dive outside of the opinion, but I wouldn't say there's any other, other than providing a model in the background information that's kind of the table stakes to, to get coverage and having that call is just really to get management to explain how they got to this project, what does it look like, have you checked all the box, the regular boxes? Right.
I guess another important thing to note is if you're, a plug for Bennett Jones is if you're getting counsel on this, you need good counsel, right? Underwriters are not interested in, you know, your divorce lawyer doing your ITC opinion. So, it's important to have competent counsel that the underage recognize and has a, has a brand name behind it because, you know, when they go get their counsel to review it, they're going to want to know where this came from and it just makes it an easier process as well when there's sort of a mutual respect for where that memo came from at the outset.
Brendan Sigalet: [00:43:02] Yeah, no, I think that makes sense. And as far as you know, pricing, what can clients look to project proponents look to expect from a pricing standpoint? I understand kind of right now, largely it's been in the realm of structure.
So, you know, these are concrete legal issues. You know, what is the reasonable allocation for a particular partner in a partnership? We can look to the case law in section 103 and kind of go from there, apply that to the facts, you know, see how it shakes out. Similar with, you know, a tax shelter investment for example, that sort of thing.
But what's the pricing been like for the deals that you've seen thus far?
Jeremy Matthies: [00:43:39] So, the deals I've seen, the pricing is sort of in that 4 to 5% rate online. So, four or 5%, 4 or 5 cents on every dollar that you need coverage for would be the premium amount. So, I think it's important because there's some different tools in the toolkit of insurance.
Like you can go out and get coverage for a select piece. I want to just know that if I don't get my ITC get it paid back and I don't care when, right? It's not a bridge, it's just regular financing. I want my $50 million bucks. I don't care if we have to go to federal court to resolve this in eight years. If I get my money back, I'm happy.
That could be the big company with deep pockets, you know? It's not the timing, I just want to know I don't have to worry about it. Whereas a smaller entity might say I'm getting a bridge, but my bridge is expiring in 36 months and I'm going to have two years of building the project. I have 18 months to get this thing paid off. If I don't get my ITC, I'm at risk of breaching and defaulting on my, on my bridge.
In that instance, what we have secured is what we're calling advanced tax payment, which as you know, for large corporations, in order, when you file your notice of objection, you have to put up half of that risk tax amount in order to appeal a reassessment.
So, the market is familiar with advanced tax payments. What we've structured is being able to say to clients, if you have a bridge, maybe you want a bridge less than a 100% of your ITC, because we can probably get you 50% of that ITC advanced tax payment provided to you so that you can actually pay off your bridge at the 36 month stage, for example, as opposed to having to wait to go through federal tax court or whatever that litigation process looks like.
You might not see that payout from insurance for five years. You need it now. So, insurers are open to that. Does that make sense? Like being, they'll front you some money, usually 50% of the limit. So, you took out $50 million and they'll give you 25 so that you can deposit it with CRA to have a fight. In this instance, you wouldn't be depositing it with CRA, you'd be using it to pay your bridge off. Right.
But they're still open to that, that structure. Initially we went out in our first deal and we were able to secure 100% of the ITC being paid back through advanced tax payment. Second deal, the markets have pulled back a little and said, hey, I don't think we're going to cover a full ITC bridge, if you want to bridge less than the full ITC we need you to have some skin in the game.
I think advances payments in the UK and in Canada generally have, there's been some pushback in the last six months in the markets, so that's a harder lift than it was a year ago or nine months ago. So my recommendation to clients on bridges is just if you have $50 million of an ITC coming your way, you may want to only bridge $25 million of that, so that we can get you the adequate coverage so that you don't default. Meaning, maybe we take out a $50 million policy, but we know that 25 will come your way if you need it before the bridge expires.
So those are just, that's pretty nuanced and it would be different for every deal, but it's something to think about because these bridge deals.
Brendan Sigalet: [00:47:21] Just to be clear on this, so you know, you're getting the advanced tax payment is a feature of the insurance. So you can get that as in order to, basically you, you have a 50% advanced tax payment to pay off, you know, 50% of whatever, it's 50% of your bridge in order to, you know, put the money up in order to fight with the CRA, you, you still have the full amount insured in that scenario.
Jeremy Matthies: [00:47:48] Yeah. So, you'd still insure the rest of the ITC if it wasn't involved in the bridge for sure. Right. It just might not come to you until after the dispute's been resolved. So, I think it's important for clients to know the coverage covers interest penalties, obviously the amount of tax that the, the refund is for. Right.
But in regular, just tax insurance, that isn't a refund. If the CRA says you owe us a hundred million dollars, your policy would be a hundred million dollars. But you'd also be adding limit for, penalties, and interest in the event that a hundred million was paid to you, is that going to need to be deemed income in your hands?
Is there a gross up needed so that you're kept whole after tax on that payout? That can be covered. Advanced tax payment, if you had to put up 50 to fight to not pay the hundred, that's coverage that's available. But you also don't need to take all those pieces. You can sort of a la carte decide, I don't need advanced tax payment, or I'm not gross up, won't apply here.
Or there's no penalty risk for us on this refund because we don't have the money in hand or no interest risk because we haven't been paid out. So, all those things are available in the coverage. There might not always be something that the client needs. So, when we look at a potential file. One of the things we ask for from the team is we need a loss calculation.
We need you to say, what's the worst-case scenario here? We'll work backwards from that. What would you like to cover? Right? So you might say, I have a $50 million tax risk, but with gross up, assuming I got taxed on a payout and with contest costs, meaning this is how much it's going to cost me to pay a lawyer to fight this, if I have to fight, you might take out $65 million of limit on a $50 million issue, right?
Because you never want to fall short on that if, if the insurer's paying for your lawyer and then, and paying penalties and paying interest. You want to run all that math on a worst-case scenario going, what if I get reassessed on the last day of this policy, right? And I've got seven years of interest in penalties. What do I owe?
So that's kind of how we start that process of valuing how much limit you need to take out in the ITC. On these bridges, it's available. I just want clients to know that we need to have a conversation early in the piece before the bank has decided how much of a bridge you're going to get.
It's for, especially for you if you're there early, to say, hey guys, when you're deciding on how much the ITC you're going to bridge, we should talk to the insurance guys to make sure we know how much coverage you can get. We know what pricing it is. Maybe you can get a hundred percent coverage. I can tell you, you can, I think it's very important that it doesn't cost any money to have that conversation early in the piece.
Brendan Sigalet: [00:50:37] Yeah, no, I think that makes sense. And Jeremy, I think it might be helpful for listeners just to kind of walk through, you know what this looks like from a practical perspective. We're talking about some complex factors here with respect to, you know, bridge financing and advanced tax payouts and payments and that sort of thing.
So, let's just say we have a, you know, a solar project, vanilla, $50 million project. They're expecting, you know, 30% of the entire capital cost in ITC. So, $15 million in ITC. And they come to you, and they ask you, you know, let's say they have it in a partnership. And you know, they're concerned about the reasonable allocation test for all parties.
So, they want to insure the entire $15 million ITC. So, you know, they want to insure, you know, the, the reasonable allocation test. They want to insure that they're sufficient at risk, they want to insure the tax shelter investment, and they want to insure that gaar as a throw in, even though probably it's not going to apply.
So, can you walk us through the process as to getting the insurance, you know, so the legal counsel's going to provide an opinion that, you know, this meets all the requirements for reasonable allocation and all that sort of thing. They get a strong should opinion that this qualifies and you know that they're all good on all those tests.
So, they come to you, they have this strong opinion, so they want to get $15 million in coverage, in order to cover that, now you would say, is that all you want to get? Is that right? Because you want to increase the amount potentially in order to cover, you know, the interest that might be owing, et cetera, et cetera. I think it might just be helpful to kind of run through a fictional example.
Jeremy Matthies: [00:52:23] Yeah. So, on that $15 million we'd sit down and say, can you talk to Brendan and find out if there's interest risk, penalty risk, gross up risk, meaning if you got paid out, would there be any tax on that? And then we would also just build in, and it's not something you flag for underwriters, but we would say, you know, and worst-case scenario, maybe you have a couple million dollars of fees if you have to fight this right to the end of the earth.
So, we might say, hey, you know, just ballparking, maybe $20 million is the limit you want to look at. So, you go out and say, okay, alright, we're going to take our $20 million policy, we've got the memo, we go to the market sign NDAs, we approach 30 different markets. The 12 that we know come that operate in Canada, we'll come back.
We'll either get quotes that say we're interested, here's our terms. And some will say maybe we're not interested for certain reasons. And if we had four quotes, for example. I would provide all those quotes to you and the client and say, here's the pricing range, here's the exclusions. Typically, they're not different. They're all willing to cover this. Who do you want to participate with?
And at that point, before you've even made a decision, it doesn't cost a client anything. I've just been out there trying to price discovery and see who's interested. And from that point, the client would say, okay, we want to go with AIG because we recognize the name and it looks like, you know, we think our stakeholders would appreciate that.
So, we go with AIG and say, "the team wants to work with you". AIG would have something called an underwriting fee where they would say, when you sign on with us, we need you to pay us, let's call it $50,000 because we use that to pay our lawyers to review your memo. And that's a non-refundable fee. So, you can include that in your premium.
So, if your quote was for $20 million at 4%. And you owe whatever that amount is $800,000 of premium, you can add $50,000 of non-refundable underwriting fee to that. And other than that, there's no other cost.
So, at the end of the day, we signed that agreement. They ask us for a list of documents that were used to write the opinion. We the client provides those. We have a due diligence call to walk through a conversation with management about the deal and the model, and a policy would get put in place. This whole process would take three or four weeks, and we would help vet through that policy, make sure all the terms are, were great, we'd bind it.
Premium would be due at the end of that whole process. And then you'd have a policy you could stick in your closing book, and you sort of move forward knowing you have coverage. What would happen, how coverage would sort of kick in, or what a claim would look like, is the solar project is done. You file your first tax return applying for the ITC, and six months later you get a letter back from the CRA saying we've assessed your project. We don't think you qualify.
We take that letter, we provide notice to AIG and say, guys, we think we have a claim. The client's been rejected. And at that point, as you can appreciate with all insurance, whether it's your house or your car or tax, usually some level of deductible that they include. We do have files where the underwriter will waive any deductible, but what the deductible is, it's called a retention.
In this case, they might say there's $150,000 retention. You started a claim. Please keep track of how much money you're spending in your correspondence back and forth. And why does that cost money? Well, because your law firm is helping you write it. Maybe you've got your accounting experts also giving you advice.
So, all of that is called contest costs. As those add up and you get to $150,000 spent, AIG is happy that you at least made an effort to try to make this go away because you can't just sort of hand them the first letter and say, start paying that a lot of these things that you know can be resolved over time with CRA and they go, okay, we see the error of our ways. The check is on the way. Your ITC is valid. We just didn't understand.
But if that the case and you get through your $150,000 of contest costs and you're still being rejected, now AIG starts paying for your legal fees and you're in the process of whatever that litigation looks like or that dispute looks like, whether it's tax court, federal court, you know, just generally debating with the audit officer at the CRA. And at the end of the day, if you come out on the wrong side of this, and if you don't get an ITC, the company would get a check for the $15 million ITC and whatever the total of all those other expenses up to $20 million.
Brendan Sigalet: [00:57:30] I think that's helpful to give the overall timeline as to how this works. And I think, you know, you'd mentioned the advanced tax payment, so that's a feature available within the ITC or the policy.
So, let's say you have the advanced tax payment. So, if you don't have the advanced tax payment, you would have to come up with the 50% of the claim in order to, you know, to stop interest from accruing sort of thing. If you have the advanced tax payment feature, then insurance will provide you that advanced tax payment to provide to the CRA in your dispute.
And if you don't, then you'd have to come up with it yourself.
Jeremy Matthies: [00:58:07] Yeah. And I don't know, you're the expert on this Brendan, but I don't know if on an ITC, I think how it would work on an ITC for advanced tax payment to actually trigger, other than in a bridge would be, here's your check for $15 million.
Six months later you get a letter going, wait a second, we shouldn't have paid you, we don't think you qualified. We took another look. You owe us $15 million back. In that instance, much like any kind of tax reassessment, they're telling you, you owe money. You're saying I don't want to pay. I think you're wrong.
You would probably have to put up seven and a half million dollars to go through that process to stop interest from occurring. To your point. So, in that instance, yes, insurance companies will pay that money for you keep your balance sheet whole, you don't have to come up with that capital to the extent it applies.
Brendan Sigalet: [00:59:05] Okay. Gotcha. And then in the bridge financing?
Jeremy Matthies: [00:59:08] Yeah. In the bridge financing, it's not that you got the money and you owe it back, because if you did get the money, you would've paid the bridge off and it would be done right. And then they'd be coming back going, we want the money. The money's been spent. We can't give it to you. But we'll have this fight with you.
In the bridge scenario where you haven't received the money and they're telling you you're not getting it, what insurers have been doing, and hopefully they continue to do, is saying, look, we understand you need to pay that off. We'll give you a type of advanced tax payment, meaning we'll front you the money before the fight so that you don't default at a certain, whatever that cost is.
So that's where, in the bridge, the advanced tax payment isn't traditionally an advanced tax payment. It's more of a mechanism to help avoid default of the bridge. But they've been calling it an advanced tax payment because that's the mechanism they're used to and it allowed us to get comfortable on the bridge side.
Brendan Sigalet: [01:00:09] Okay. I think that makes sense. So just as far as final thoughts for companies considering tax insurance for their clean energy projects, what are some of the key steps they should take?
Jeremy Matthies: [01:00:19] Well, I think they should, when they're sitting down with you, it probably makes sense for them to discuss, you know, is insurance something that will help us maximize our use of capital?
Is this something that our lenders are going to want to look at? Is this something that any other third-party stakeholders are going to want us to have? And maybe we should investigate this now as we're structuring. I just think the earlier in the piece that the insurance can be considered is the better one is now you're going to be writing a memo that takes time trying to jam insurance at the end of your deal.
It can be done, we can, we've done deals in seven days, but it's always better to have more time, much like someone comes to you for legal work. The more time you have the better job you can do. So, I think just being open to the fact that this is an option. And then exploring it if you think it is an option, allows us more flexibility to find you the right product, to get you the right partner and to get the best pricing.
If it's later in the day and it becomes apparent that you're going to need it, we can act quickly. We're all lawyers and we're all used to working under time crunches. We don't, you know, the clock doesn't stop on the weekend. We work as much as we have to, to get it done. So, I think it is important to know that just because you didn't get in us in the door a month ahead of time doesn't mean you can't use it.
So, I think structure is an early, early discussion and because structure's insurable, I think it's also important to know, hey, we could have gone that path. We may have been able to ensure that and got everyone happy. Instead, we went the safer route, which maybe some of our investors weren't as pleased with because we weren't allowed to do the partnership. Right. It's probably worth a phone call.
Brendan Sigalet: [01:02:15] No, I think, I think that makes a lot of sense and uh, you know, just kind of mapping it out as, you know, opposed, you know, with the, the potential risk and the cost of covering that risk as opposed to the certainty, you know, just deciding to go with the taxable Canadian corporation offers. I think it's helpful to, you know, map that out at the outset.
Jeremy Matthies: [01:02:36] Yeah. I've had clients call me while they're looking for a lender and they've got ERMS from a US lender. That's, you know, a non-traditional source, but they're quite flexible, but mandates that they get insurance, or they go to a big bank in Canada that maybe doesn't need the insurance, but they're not as happy with the terms.
So, there is, I think even at that lender stage, as Canadian businesses sort of go further down market to look for lending options, I think it's going to become more important that insurance is canvased early in the piece.
Brendan Sigalet: [01:03:18] And I think, you know, from the tone of our conversation today, it sounds like you're pretty bullish as far as tax insurance and the clean economy ITC space in Canada.
But do you have any thoughts as to how you see the role of tax insurance evolving in Canada generally, or in the clean economy ITC standpoint?
Jeremy Matthies: [01:03:35] Yeah. Other than the fact that I think there's still lots of education to be done, which things like this podcast are helpful with. A lot of clients, and you probably know this, don't know, it's, it's an option. And don't understand that this is something that they can help to de-risk the tax piece of their deal.
I would say regardless of the government, we have, you know, case laws changing all the time and tax insurance that's kind of been around long enough to have dealt with all those sorts of changes like the US is dealing with it now and a change of administration really, it still serves the same purpose.
So, I don't see it going anywhere. I see it growing just through education and whether that's ITCs or otherwise. But I think the longer that a product is in the market, like, you know, the renewable ITC product, I think the more flexible it becomes the same, you know, from your perspective, it's probably the same in your business.
The longer this legislation exists, the more time smart people have to figure out ways to save money doing it. And even if the legislation gets tweaked or things change, all those changes make tax that much harder to put your finger on and all that much more important to be able to crystallize that risk for a business.
Brendan Sigalet: [01:04:58] No, I think it's just an immensely valuable tool. Thank you so much for your time today. I really appreciated the conversation. I think, you know, from my perspective, this industry is just going to continue to grow. I think, you know, 20 years ago there wasn't this capability to, you know, crystallize the risk as you put it.
I think that tax advisors such as, you know, myself and others are increasingly becoming aware and live to, you know, this potential tool in our toolbox and it's just going to continue to lead to further development of this industry and risks that can be crystallized as we put it sort of thing as we move forward. Thanks so much for your time today, I really appreciate it.
Jeremy Matthies: [01:05:38] Thanks for having me and ever need me, you know where to find me.
Brendan Sigalet: [01:05:47] Absolutely.
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