Transcript The Greening of the Federal Tax Code

The Greening of the
Federal Tax Code
Renewable Energy Tax Credits
Presented By:
Nate Smithson
Jackson Walker L.L.P.
901 Main Street
Suite 6000
Dallas, Texas 75202
(214) 953-5641
[email protected]
© December 5, 2011
This presentation represents only a summary of the applicable
provisions with respect to renewable energy tax credits and related
matters set forth in the Internal Revenue Code of 1986, as amended
from time to time (the “Code”), revenue rulings and administrative
interpretations (all as currently in effect and all of which are subject to
change, possibly with retroactive effect).
This presentation does not constitute tax, legal or other advice from
Nathan Smithson or Jackson Walker L.L.P., and neither assumes any
responsibility with respect to assessing or advising the reader as to tax,
legal or other consequences arising from the reader’s use of the
information.
This presentation is not intended or written to be used, and may not be
relied upon, by any person for the purpose of avoiding penalties that
may be imposed under any federal tax law or otherwise.
The Push for Renewables
• Federal Government:
– The Carrot: Tax Credits for investment and
production
– The Stick: EPA limits on pollutants
• Local Governments:
– Renewable Energy Standards across all
states that provide fungible, valuable energy
credits.
Personal Choices
• More people looking to reduce their
carbon footprint (i.e., global warming
fears)
• Reduce dependency on foreign resources.
Wind Farm Scenario
Why a Wind Farm?
• Many opportunities in west Texas and the
panhandle.
• Can build and co-exist on land currently
used for ranches, among other things
– Benefit for the land owner
• Relatively quick to set up – purchase to
generation within a few months
Wind Farm Facts
• Over 35,000 electricity producing wind
turbines in the world
• 800 wind farms within the US for a total of
43,000 Megawatts of capacity (3.25% of
US total energy capacity)
• Texas has the most wind farms of any
state, with a total capacity of over 10,000
Megawatts -- Enough to power:
– 100,000 100w light bulbs
Current Drawbacks to Wind Power
• Efficiency: Wind has to be blowing over
20mph to cause a 2 MW wind turbine to
generate 2MW of electricity
– Efficiency of 30% is pretty good
• Timing: Wind is at its highest at night, and
due to lack of storage for the wind, its
peak comes when most homes do not
need it.
Drawbacks cont’d
• Transmission: As wind farms are generally
located in more remote areas, the ability to
get the electricity to the hubs in hampered:
– Dearth of transmission capacity currently;
– Loss of strength in transmission.
Turbine Facts
• A 2MW turbine costs approximately $3.5
million, delivered and installed
• 3 main components:
– Tower: 80-100 meters
– Nacelle: 8-10 tons
– Blades: 35-55 meters
Our Wind Farm
The “Dallas Bar Wind Farm”
Dallas Bar Wind Farm
• 10 2MW Wind Turbines located on a farm
in west Texas.
Total cost:
$35 million
Estimated start of construction:
December 15, 2011
Dallas Bar Wind Farm
20 MW of total capacity
• At 45% efficiency: 78,750 MWh per year
– Serving 7000 “average” households
• At 30% efficiency: 52,500 MWh per year
– Serving 4700 “average” households
• At 15% efficiency: 26,250 MWh per year
– Serving 2350 “average” households
Federal Tax Opportunities
•
•
•
•
Production Tax Credit
Investment Tax Credit
Section 1603 Cash Grant
Accelerated Depreciation
Production Tax Credit
PTC = 2.17¢ * kWh produced
from Qualified Energy
Resources at a Qualified
Facility
Production Tax Credit
•
Available over the 10 year period starting
on the date the Qualified Facility was
originally placed in service.
•
Electricity must be sold to an unrelated
person.
•
Electricity must be produced in the US
or a US possession.
“Sold to an Unrelated Person”
• Where electricity is ultimately sold to an
unrelated person, an intermediate sale of
the electricity to a related person for resale
will still qualify for the Production Tax
Credit.
– OK to sell to a partner in a partnership that
ultimately resells this on the market
Qualified Energy Resources
• Wind, solar energy, geothermal energy,
hydropower production, etc...
– See Appendix A to the outline for a description
of the type of facilities associated with these
resources.
Qualified Facility
• Facilities producing electricity from qualified energy
resources
– more specifically set forth in Code section 45(d) (and Exhibit A)
• A wind facility placed in service after December 31, 1993
and before January 1, 2013 constitutes a qualified facility
– Placed in service = placed in a condition or state of readiness
and available to produce electricity
– Note – extended through 2012 by the American Recovery and
Reinvestment Act of 2009 (the “ARRA”)
DBA Wind Farm
30% Efficiency = 52,500 MWh
• Results in a credit of:
– $1.14 million annually, or
– $11.4 million over the 10 year PTC period.
• Approximately 33% of the total cost is returned
• Estimated Present Value: $8.8 million
– 25% return on investment
DBA Wind Farm
45% Efficiency = 78,750 MWh
– “Rock Star”
– $1.7 million annual credit
– Estimated Present Value: $13.2 million
15% Efficiency = 26,250 MWh
– “Basement Band”
– $570,400 annual credit
– Estimated Present Value: $4.4 million
Investment Tax Credit
ITC = Energy Percentage *
Basis of Energy Property Placed in
Service
Energy Percentage
Either:
– 30% for certain enumerated property; or
– 10% for all other property
30% Property
• Initially, this was certain limited scope
property that was generally not included
within the ambit of Code section 45.
• ARRA added the provision: “Qualified
Property” that is part of a “Qualified
Investment Credit Facility”
Qualified Property that is part of a
Qualified Investment Credit Facility
•
Qualified Property: Depreciable or amortizable
personal property, or other tangible property if
used as part of a Qualified Investment Credit
Facility.
•
Qualified Investment Credit Facility:
–
–
A wind facility placed in service by
December 31, 2012.
Any other qualified facility described in Code
sections 45(d)(2) – (4), (6), (7), (9) OR (11) that is
placed in service between January 1, 2009 and
December 31, 2013.
Energy Property
•
Certain energy property described in Code
section 48(a)(3); provided that such property:
–
–
–
•
Was either constructed and completed by the
taxpayer requesting the credit, or acquired by such
taxpayer, if the original use of such property
commences with such taxpayer;
Is subject to deprecation or amortization; and
Meets certain performance and quality standards
set forth by the Department of the Treasury; and
Qualified Property that is part of a Qualified
Investment Credit Facility.
Basis
•
Only the cost of the property and installation.
•
Basis does not include the cost of any property
to which it is attached (e.g., cost of the solar
panel placed on a building, but not the cost of
the building itself).
•
Basis of the Energy Property will be reduced
by 50% of the Investment Tax Credit allowed.
Recapture
•
Applies to the ITC, but not the PTC
•
The ITC will be recaptured if the Energy Property is
sold or ceases to be eligible for the credit
•
100% of the credit is due if the disqualifying event
happens within 1 year of placed in service.
–
Reduced by 20% per each year thereafter.
–
Thus, after the 5th year placed in service, the Recapture
Percentage is 0%.
ITC for the DBA Wind Farm
30% * cost basis of $35 million
=
$10.5 million
Section 1603 Cash Grant
Grant = Applicable Percentage *
Eligible Basis of Specified Energy
Property Placed in Service
Cash Grant Highlights
•
Direct payment of cash to the taxpayer
once property is placed in service (within
60 days)
•
Not includable within the gross income of
the taxpayer
Cash Grant Facts
• 22,747 projects funded to date
• $9.6 billion in grants made
– At up to 30% of the eligible basis, this reflects $32.9 billion in
total federal and private investments
– $1.6 billion in funding in Texas alone for 288 projects
• 14.3 GW of installed capacity resulting from grant funded
projects
• 36.8 TWh of estimated electricity generation
– 3.3 million “average” homes
Applicable Percentage
• Either 30% or 10%, as set forth in
Program Guidance from the Department of
the Treasury, revised as of April, 2011.
• Generally mirrors the ITC Energy
Percentage
Specified Energy Property
•
Certain Qualified Facility Property
eligible for the Production Tax Credit;
and
Certain Energy Property eligible for the
Investment Tax Credit
•
–
Both are further set forth in Program
Guidance from the Department of the
Treasury, revised as of April, 2011.
Eligible Basis
•
The cost of the Specified Energy
Property
–
–
–
Includes installation and shipping costs.
Also includes roads and parking areas to be
used for the transportation of material for
processing or equipment for maintenance
and operation of the facility
Does not include roadways and parking that
are provided for employees and visitors.
Non-Eligible Basis
• Costs that will be deducted in the year in
which they are paid or incurred:
– Code section 179 deduction.
– Election to expense intangible drilling and
development costs.
Basis
• As with the ITC, the basis of Specified
Property will be reduced by 50% of the
amount of the Cash Grant.
Eligibility
•
Must:
–
–
•
Own and continue to own the eligible property; and
Originally place it in service
A lessee of property can apply too, provided that:
–
–
–
–
A valid lease is included in application;
The owner/lessor waives its right to the payment;
Both lessor and lessee are otherwise eligible to receive the
credit; and
Lessee agrees to include ratably in gross income over the five
years an amount equal to 50% of the grant amount.
Eligibility
• Cannot be an exempt entity, a
governmental entity, an energy co-op or a
partnership with a such an entity as an
owner, unless owned through a blocker.
• OK to have a foreign owner provided that
50% of the gross income of such foreign
owner with respect to the project is subject
to taxation at the federal level.
Eligibility
• Original use of the property must start with
the applicant.
– Less than 20% of the total cost of the facility
can be made up of used parts.
– OK to use a sale-leaseback if within 3 months
of original placing in service.
Eligibility
• Property must be used predominantly in
the US.
• Project must have started by 12/31/11
When to Apply
•
Application Deadline: October 1, 2012
– If not placed in service by the application
deadline, then additional information must
be submitted within 90 days after being
placed in service
– Credit terminates if not placed in service by
the credit termination date – January 1,
2013 for wind.
Documentation Requirements
• Must show that:
– 1) the property is eligible;
– 2) it has been placed in service; and
– 3) the amount is accurate.
Documentation
•
Eligibility of the property – design plans
stamped by a licensed professional
engineer
Documentation
• Placed in Service:
– Commissioning report from an engineer,
vendor or qualified 3rd party that equipment
works for its intended purpose; and
– an interconnection agreement for facilities
interconnected with a utility.
Documentation
• Accuracy – Detailed breakdown of all
costs, and an independent accountant’s
certification if basis is over $500,000
Documentation
• If the property will be placed in service
after December 31, 2011, must
demonstrate that “physical work of a
significant nature” has begun on or before
December 31, 2011
– This is the beginning of construction
Physical Work of a Significant
Nature
•
Includes work both at the site as well as
the prep work with respect to the facility.
•
Does not include preliminary activities
such as planning or designing, clearing a
site, acquiring financing, changing the
contour of land.
Physical Work of a Significant
Nature – Wind Turbine
• Examples for a wind turbine:
– On-site: excavation of foundation, setting
anchor bolts or pouring concrete pads.
– Off-site: the beginning of the manufacturing of
the component parts of the turbine –
**The component being manufactured must be
associated with the applicable facility being
constructed.
Physical Work of a Significant
Nature – Work Under Contract
• Contracted work qualifies if:
– Entered into prior to the start of such work;
– The contract is binding and enforceable under
state law against the applicant; and
– Does not limit damages to a specified
amount.
Physical Work of a Significant
Nature – Safe Harbor
• Safe Harbor: Physical work of a significant
nature has begun when 5% of the total cost of
the property has been paid or incurred.
– When constructed by the applicant – when paid or
incurred by the applicant.
– When constructed for the applicant under a contract –
the contractor must itself incur such costs to be
effective.
• The above costs can be combined.
• This requires substantiation.
Physical Work of a Significant
Nature – Multiple Units
• An applicant can elect to treat multiple
independent units as a single unit for
purposes of determining the beginning of
construction (e.g., an applicant building a
wind farm can treat all turbines as a single
unit).
Physical Work of a Significant
Nature – Continuity
• Work must be continuous – cannot start
work in 2011 to meet the “beginning of
work” requirement followed by a long
hiatus.
– OK to stop because of conditions relating to
the time of year.
– Not OK to stop because of lack of
funds/supply.
Recapture
• The Cash Grant will be recaptured if the Energy
Property ceases to be eligible for the grant.
– This differs from the ITC in that a sale of the property
will not necessarily cause a recapture event.
• Similar to the ITC, 100% of the grant amount is
due if the disqualifying event happens within 1
year of placed in service, reduced by 20% per
each year thereafter.
DBA Wind Farm Cash Grant
30% * cost basis of $35 million
=
$10.5 million
Adjustments to Basis
Basis
• PTC – No adjustment Required
• ITC – Basis is reduced by 50% of the ITC
amount
• Cash Grant – Basis is reduced by 50% of the
Cash Grant
• Recapture – Basis will be increased by 50% of
the recapture amount.
Bonus Depreciation
Bonus Depreciation
• Code section 168(k) – deduction of 50% of the
adjusted basis of property in the first year
qualified property is placed in service after
December 31, 2007 and before January 1, 2013.
*** 100% if placed in service before January 1, 2012***
– relates to the original use of property
• Qualified property includes property that has a
recovery period of 20 years or less.
– Both solar and wind energy property are treated as “5
year property” for purposes of Code section 168.
Bonus Depreciation
• The lessor of property may also use bonus
depreciation if:
– If all of the 168(k) requirements are otherwise
met; and
– The property is sold and leased back within a
3 month period of being placed in service.
DBA Wind Farm Bonus
Depreciation
(assume placed in service in 2012)
• If using the PTC:
$35 million depreciable basis * 50% =
$17.5 million depreciable currently
• If using the ITC or Cash Grant:
$29.75 million depreciable basis (reduced by $5.25
million required adjustment) * 50% =
$15 million depreciable currently
Summary of Federal Benefits
for DBA Wind Farm
DBA Wind Farm Summary
• If efficiency is 30% and the PTC is used:
– Annual Credit of $1.14 million for 10 years (Present
Value: $8.8 million)
– 2011 Accelerated Depreciation: $17.5 million * 35% =
$6,125,000
– 2011 benefit = $7.2 million
• If efficiency is 45%, 2011 benefit = $7.8 million
• If efficiency is 15%, 2011 benefit = $6.7 million
DBA Wind Farm Summary
• If the ITC or Cash Grant is used:
– Credit/Grant of $10.5 million
– 2011 Accelerated Depreciation: $15 million *
35% = $5,250,000
– 2011 benefit = $15.75 million
Financing Opportunities
Solo Financing
• The Cash Grant program provides direct
funding to a developer
– Reduces the ultimate amount of financing
necessary to develop a project.
DBA Wind Farm Solo Financing
• Our initial outlay of $35 million is really a
$24.5 million outlay following the receipt of
cash.
– The $5.25 million accelerated depreciation
deduction doesn’t do much good:
• we don’t yet have the income to be offset by the
deduction.
Flip Partnership
Flip Partnership
• By bringing in investor partners, the
developer of a project has the opportunity
to pass through to the investors certain of
the currently recognizable benefits.
Flip Partnership
• General Structure:
– Investor puts in money;
– Developer puts in know-how and some capital;
– Allocations:
• 99-1 between investor and developer so that investor
receives the credits, along with income items;
– Distributions:
• First to developer until it receives its return;
• Then to investor until it receives the negotiated return –
taking in to consideration the allocation of credits;
• Then flip to developer – possibly with purchase right
Flip Partnership – Safe Harbor
• Treasury has established, under Notice
2007-65, a safe harbor for “wind farm”
partnerships, so that if the terms of the
safe harbor are met, the IRS will respect
the allocation of Production Tax Credits.
Safe Harbor Requirements
• 1) Partnership must own the applicable wind
property;
• 2) Developer must have at least 1% interest in
partnership income, gain, loss, deduction, and
credit at all times;
• 3) Each investor must have minimum interest in
each material item of income and gain equal to
5% of such investor’s percentage interest in
partnership income.
Safe Harbor Requirements
• 4) Each investor must maintain a minimum investment in
the partnership of 20% of its capital requirements.
– Can be reduced by cash flow distributions.
– Such amount must not be protected against loss.
• 5) Any purchase right with respect to the partnership
property must:
– Be either:
• The fair market value of the property determined at the time of
exercise; or
• If the purchase price is determined prior to exercise, the estimated
fair market value of the property at the time the right may be
exercised.
– Not be exercisable by the developer earlier than 5 years after the
facility is first placed in service.
Safe Harbor Requirements
• No investor may have a “put” right with
respect to its partnership interest, and the
partnership may not have a “put” right with
respect to the partnership property.
• Each partner must fully bear the risk of the
investment in the property (no guarantees)
Sale-Leaseback
Sale-Leaseback
• Typical Steps:
– Developer builds and places the applicable
property in service;
– Developer sells the property to an investor;
– Investor leases the property back to
developer in a “true lease;”
– Investor avails itself of a Credit or the Cash
Grant and the accelerated depreciation.
Timing
• Investor must acquire the applicable
property within 3 months of it being placed
in service in order to receive the Credit or
Cash Grant.
“True Lease”
• Treasury guidance:
Revenue Procedure 2001-28
• 1) The lessor must have made a minimum unconditional
“at risk” investment in the property at the outset and such
minimum investment must remain throughout the entire
lease term until the end.
– Minimum investment -- at least 20% of the cost of the property
– Must be unconditional (i.e., lessor must not be entitled to a return
of any portion of the minimum investment from lessee).
True Lease
• 2) The lease term (including all renewals
or extensions) must be at fair rental value
(determined at the time of such renewal or
extension).
• 3) Lessee cannot have a contractual right
to purchase the property at a price less
than its fair market value, determined at
the time the right is exercised.
True Lease
• 4) Lessor may not have a “put” right with respect
to the property (when placed in service).
• 5) Lessee cannot make nonseverable
improvements.
• 6) Lessee may not loan money to lessor with
respect to the property, or guarantee any loans
with respect thereto.
True Lease
• 7) Lessor expects to make a profit on the
ownership and lease of the property, which
profit shall not take in to consideration any
tax benefits.
• 8) The lease period must be less than the
entire useful life of the property.
Flip Partnerships v. SaleLeasebacks
•
Sale-leaseback does not work for PTCs as they can
only be claimed by an owner and operator of the facility;
•
Lessor can receive 100% of the tax benefits, whereas in
a partnership, the developer would be required to have
at least a 1% interest therein;
•
Sale-leasebacks with ITC and accelerated depreciation
generate upfront tax benefits to an equity investor and
do not directly depend on productivity of the facility or
demand for the energy.
Flip Partnership v. Sale Leaseback
• Easier for the developer to benefit in a flip partnerships
following the full realization of the credits (can end up
with a 95% interest post-flip);
• Fair market value of the property upon a developer
buyout must be determined at the time of exercise in a
sale-leasebacks, instead of pre-determined based on
estimates in a flip partnership;
• Investor need not participate in the operations of the
project in a sale-leasebacks.
• Investor doesn’t need a profit motive in a flip-partnership.
Inverted Lease
Inverted Lease
• Developer leases the applicable property to an
investor, who sells the electricity generated
therefrom.
• Developer may pass through the Investment Tax
Credit or the Cash Grant, subject to a valid
election, provided:
– the investor is eligible to receive such benefit; and
– in the case of the Cash Grant, the investor agrees to
return 50% of the amount of the grant over the
recapture period.
Inverted Lease
• Developer would receive rent and be able
to take depreciation deductions.
• At the end of the lease term the developer
owns the property.
Texas Specific Impact
Texas Specific Impact
•
Texas’ grid:
–
–
•
Isolated – ERCOT relies almost entirely on internal
resources to serve its load and reserves.
A report from the North American Electric Reliability
Corporation suggests that Texas may not have the electrical
reserves to meet peak demand by 2013.
New environmental regulations will result in the
mothballing of generating units, and added to the
current drought, the power supply in the next year
may soon fall short of ERCOT’s minimum target.
Texas Specific Impact
•
Texas Renewable Portfolio Standard - enacted
in 1999
–
–
The program required electricity providers
collectively generate 2,000 megawatts (MW) of
additional renewable energy by 2009 (met in 6
years).
The 2005 Texas Legislature increased the state's
total renewable-energy mandate to 5,880 MW by
2015 (500 of which must not be from wind) (also
surpassed) and a target of 10,000 MW in 2025.
Renewable Portfolio Standard
Each provider is required to obtain new
renewable energy capacity based on their
market share of energy sales times the
renewable capacity goal.
Example: a retailer with 10 percent of the
Texas retail electricity sales in 2011 would
be required to obtain 200 megawatts of
renewable energy capacity
Renewable Energy Credits
•
One REC represents one megawatt-hour of
qualified renewable energy that is generated
and metered in Texas.
–
•
No requirement to actually take delivery – highlights
the transmission problem out in west Texas
The REC trading system created great
flexibility in the development of renewable
energy projects.
Competitive Renewable Energy
Zones
•
Public Utility Commission has been assigned
almost $5 billion of CREZ transmission
projects to be constructed by 7 transmission
and distribution utilities (such as Oncor)
•
Intended to transmit almost 18,500 MW of
wind power from west Texas and the
panhandle to the highly populated areas
•
Currently working, but much is not expected to
be completed until 2013
Nate Smithson
[email protected]
(214) 953-5641