Transcript Using Federal PTC’s and Clean Renewable Energy Tax Credit

Using Federal PTC’s and Clean Renewable
Energy Tax Credit Bonds in Financing Wind
Trintek Energy Consulting, Inc.
Creating Competitive Advantage Thru Intelligent Development
Native Renewables Energy Summit
November 15-17, 2005
Discussion Outline
PART 1
•PTC’s - Production Tax Credits
•Qualification For and Use of PTC’s
•Allocation of PTC’s in Deal making
•Expected Returns and Disproportionate Allocation
of PTC’s
•Justifying Disproportionate Allocation
•Implied Tradeoffs For Disproportionate Allocation
PART 2
•Clean Renewable Energy Tax Credit Bonds
PART 1 - PTC’s - Production Tax Credits
•IRS Section 45
•1.9 cents/Kwh adjusted for inflation each year
•Turbines must be placed in service and produce electricity
before the expiration date of the PTC then in effect.
•NPV value is worth about 33% of capital cost of a typical project
•The PTC gets IRS imposed “haircuts” for project subsidies such as:
state credits, tax exempt financing, and some other kinds of credits
-The key is generally if it reduces “cost” or capital or is tied to output
-Old PPA’s w/above market pricing-special cases
-REC’s are tied to output-therefore, no haircut
Qualification For and Use of PTC’s
•An entity must own the generating asset and produce and sell
electricity to an unrelated 3rd party to qualify
•It is essential that one of owners have federal taxable income against
which credits can be used
•If not in a taxable position, then a developer can sell a portion
of the project to an investor with a tax appetite
Taxpayers may apply the credit against AMT only during the
first 4 years of a new project
•Credits can be carried forward 20 years or carried back one year
Qualification For and Use of PTC’s
•Qualification for the PTC is subject to passive loss rules,
limiting small individual investors S Corps and C Corps
to offset income only from other “passive” investments
-(Hint, Most small individual investors do not have large amounts
of “passive” investment income on a recurring annual basis)
•The intent of the tax code is to prevent individuals from owning a
passive investment which generates a credit against normal wage
and investment portfolio income
•These passive loss rules do not apply to larger Corporations
Allocation of PTC’s in Deal Making
•Project participants can allocate substantially all the tax benefits
in proportions ranging from a 90%/10% split to a 99%/1% split
from the project to the partner/investor who can use them
for 10 years or until a specified IRR is met
•After either a 10 year period or a specific IRR is met, ownership
then flips to ownership interests which are in favor of other
party ranging from 20%/80% to 5%/95%
•Probably should get a tax opinion on “residual interest” percentage
that will withstand IRS scrutiny on audit. Some may say
that 10% minimum residual interest is required
•The developer of the project, takes the risk of putting the project
in service by the tax qualification date, and will have to give an
indemnity if favor of the investor including reallocation of
cash flows for failure to qualify for the PTC
Allocation of PTC’s in Deal Making
•The investor/partner agrees to makes capital contributions
in favor of the project company to secure the cash flow required
to service debt and operate the project
• The investor/partner essentially supports the debt by taking
tax law and change of law risk in return for the expected value
of the the future tax credits it forecasts it will monetize
•The investor/partner must make contributions to support the debt
even if:
-The investor ends up not being able to use the tax credits
-Congress repeals the credits
-The wind turbines do not get put on line in time to qualify
•The investor actually only has to make the contributions to the level needed to
hit the specified DSCR’s
Expected Returns and Disproportionate Allocation of PTC’s
•The investors who participate in wind energy projects
for the tax credits will expect un-levered returns of 8.5-10%
•If they are willing to take construction risk and to participate early
in the project, their expectation will be 10-12.5%
•Proportionate vs. disproportionate cash and tax allocation
•Historically, many industry tax attorneys have been unwilling to
give opinions on disproportionate allocations of cash versus
tax credits among partners and investors
•Some industry experts are now opining that if risks among the
parties can be “significantly differentiated” then there may be flexibility
to allocate credits in a different proportion to a partner’s initial capital
contribution
Justifying Disproportionate Allocation
•Federal tax rules require substantial economic consequences
commensurate to the benefits attached to any special allocations
of taxable income and deductions
• Upon audit, an investor must show there was economic justification
for a disproportionate allocation of tax credits and be able to show
“differentiated risks”
• The downside is to risk disallowance and unwinding of the structure
entailing financial consequences to the investor and the project
“Allocation of Benefits Back at the Ranch”
Allocation of benefits in deal making can be tricky.
Don’t get your deal “unwound” by the IRS and blown away
Implied Tradeoffs For Disproportionate Allocation
•Deductions that create a deficit in a partner’s capital account are
not allowed unless the partner is obligated to restore that capital
account in the event of a liquidation of the partnership
•Restoration of a deficit is the economic consequence for taking
disproportionate deductions due to disproportionate allocation
of depreciation or credits
•Over the long term, deficits will eventually be erased, but this
underscores that longer term commitments and less
flexibility/liquidity are also required to participate disproportionately,
and may increase audit potential
•It may be best to get a letter opinion from the IRS
Example of DSCR Calculation Including PTC’s-BASE CASE
2008
2009
2010
2011
2012
2013
2014
Total Revenue
Total Operating Expenses
Operating Profit (Loss) Ebitda
Depreciation
State Tax
Interest Expense
Net Income (Loss) before taxes
12,480,880
1,905,165
10,575,714
31,787,151
0
7,164,980
-28,376,417
12,788,304
1,928,245
10,860,059
50,606,270
0
6,909,893
-46,656,104
13,103,414
3,076,674
10,026,740
30,532,544
0
6,636,185
-27,141,988
13,426,402
3,133,146
10,293,256
18,488,308
0
6,496,584
-14,691,636
13,757,464
3,195,204
10,562,260
18,488,308
0
6,180,610
-14,106,658
14,096,803
3,262,532
10,834,271
9,455,131
0
5,848,855
-4,469,716
14,444,625
3,334,951
11,109,675
421,955
381,102
5,599,501
5,469,322
Operating Profit (loss) Ebitda
Production Tax Credits
Administration of Project(Subordinated)
Total Cashflow Available For Debt Service
10,575,714
5,192,055
150,000
15,917,769
10,860,059
5,321,856
153,750
16,335,665
10,026,740
5,454,903
157,594
15,639,237
10,293,256
5,591,275
161,534
16,046,065
10,562,260
5,731,057
165,572
16,458,890
10,834,271
5,874,334
169,711
16,878,316
11,109,675
6,021,192
173,954
17,304,821
Total Debt Service
10,611,846
10,890,443
10,426,158
10,697,377
10,972,593
10,229,282
10,487,770
1.5
1.5
1.5
1.5
1.5
1.65
1.65
DSCR constraint
*For a 100 MW Project with 35% Capacity Factor
PART 2 - Clean Renewable Energy Tax Credit Bonds
•Clean Renewable Energy Bonds are bonds issued by or on
behalf of Electric Coops, State and local governmental bodies, or
Indian Tribal Governments
•Must be issued to finance the capital expenditures of
“qualified borrowers”
-I.e., governmental bodies and Electric Coops, and Indian Tribal
Governments
-Therefore it appears these same entities must own the facilities
-Appears there is room for joint ownership with private enterprise
-No restriction on who can operate
-Can sell output to anyone
Tax Credit Bonds (Continued)
•A total capacity of $800 MM in bonds can be issued
• $300 MM reserved for Electric Coops
• If demand exceeds supply, the IRS will allocate/ration
among the parties requesting permission to issue bonds
•An issuer, must have a “receipt of allocation” approval
from the U.S. Treasury to issue the bonds
•Have to be issued in 2006 and 2007
Tax Credit Bonds (Continued)
•An issuer must spend the proceeds from bond issuance
within 5 years from bond issuance
•But, an issuer may petition the IRS for a reasonable extension
if reasonable cause can be shown
•95% of the proceeds have to be spent on the kinds of facilities
that would qualify for the PTC
Tax Credit Bonds (Continued)
•Terms of bonds will be number of years that equates the present
value of the principal repayments equal to ½ the amount of principal
originally borrowed
•There is no interest payment made to bondholders on these bonds
•Instead they will receive a quarterly accruing tax credit from the
IRS in lieu of interest
•Congress directed the IRS to calculate the minimum tax credit
that bondholders would need to be offered to forego normal interest
so that there is no discount to or interest paid by the issuer
Tax Credit Bonds (Continued)
•The U.S. Treasury already does an analogous calculation for
“qualified zone academy bonds” which are bonds issued to
finance improvements at public schools in low income areas.
•The credit term and rate in August 2005 on these bonds was 16
years and 5.3% interest rate
•Principal repayments must be level over the term
•Bondholders who receive the tax credit in lieu of interest must
then report this as income and pay tax on its value
•More definitive rules coming 120 days from Aug 8th