Clean Energy:Federal Tax Compliance Issues

Wendy C. UnglaubMorgan, Lewis & Bockius LLP

March 26, 2010Wendy C. UnglaubMorgan Lewis Tax Practice

A presentation for the New Jersey Clean Energy Forum

Wendy C. UnglaubMorgan Lewis Tax Practice

A presentation for the New Jersey Clean Energy Forum

2

Overview

• Significant tax benefits available for renewable energy (solar, wind, geothermal, trash-to-energy, hydropower) projects

• Key tax benefits include investment tax credit (“ITC”), production tax credit (“PTC”) and, if extended, bonus depreciation

• Limitations on tax benefits limited pool of investors and players in this area

• Tax legislation in 2008 and 2009 extended the term and extent of tax benefits

• State benefits may also be significant

3

Investment Tax Credit

• ITC of 30% of cost for eligible property – includes equipment used to generate electricity, heat or cool a

structure, illuminate the inside of a structure using fiber-optic distributed sunlight)

– does not include electrical transmission equipment such as transmission lines, towers, and transformers.

• Recent legislative changes include:– extension of ITC thru 2016– available to public utilities– offsets AMT– grant in lieu of credit– ability to elect PTC in lieu of ITC

4

Investment Tax Credit

• ITCs are available only to owners of a facility at the time it is “placed in service.”– “Placed in service” means that time when the property is first

available for its intended use. – Caution – a seller may have already placed property into service.

• ITC reduces basis of the solar property.

• ITC can be “recaptured” if interest is sold within five years.

5

Production Tax Credits

• Production tax credit (“PTC”) of 1.5¢ x kilowatt hour (before inflation adjustment) for first 10 years of service

• Many states follow federal rules• Recent legislative changes include:

– Extension of PTC thru 2012 for wind energy, expanded coverage

– Extension of PTC thru 2013 for geothermal, biomass, solar, trash-to-energy, hydropower, marine and hydrokinetic facilities

– Ability to elect ITC as an alternative to PTC– Grants in lieu of credits

6

Production Tax Credit – Partnership “Flips”

• Investor allocated most of gross income, depreciation, and PTCs (collectively, the “Tax Items”) and a relatively smaller share of cash receipts until Investor reaches a target IRR (“Flip Date”).

• Sponsor has relatively small allocation of Tax Items, but a higher share of cash receipts until Sponsor equity is repaid.

• At Flip Date, allocations of Tax Items are reversed to equal allocations of cash receipts.

Partnership

Investor Sponsor

95% tax5% cash

5% tax95% cash

Pre-flip

Partnership

Investor Sponsor

95% tax95% cash

5% tax5% cash

Post-flip

7

Partnership “Flips” & Rev. Proc. 2007-65

• Rev. Proc. 2007-65 creates a safe harbor treating a partnership flip structure is a valid way to allocate wind energy PTCs (other PTCs not covered) if (in general):– Sponsor has at least 1% interest in income, deductions and credits throughout term of

facility.– An Investor’s interest in income or gain cannot be flipped below 5% of the Investor’s largest

sharing percentage of income or gain for any prior year.– Investor must make at least 20% of its total investment up front, no more than 25% of total

investment obligation may be contingent.– No party may have below-FMV purchase option, and sponsor may not have purchase

option for at least 5 years.– Partnership may not have right to put facility, and investor may not have right to put interest.– No person may guarantee that investor will be allocated the PTC.– Partnership must generally bear risk of wind availability.

• These requirements are not to be used by IRS agents as audit guidelines.

8

Investor-Related Tax Issues

• Structures for fund investors similar to private equity or real estate fund models

• Structures for industry investors depends on particular circumstances

• Structures include:– Limited liability companies (“LLCs”) and other entities treated for

U.S. tax purposes as partnerships– Corporations (including “blockers”)– Purely contractual arrangements

9

Tax Concerns Depend on Nature of Investors

• U.S. taxpayer investors– In the fund context, typically includes principals

or managers of U.S.-based fund– Individuals and other non-corporate investors

subject to passive loss, at-risk and other restrictions on deductions

– Multi-national corporate investors have special concerns and opportunities

10

Tax Concerns Depend on Nature of Investors

• U.S. tax-exempt investors– Concern regarding unrelated business taxable

income (“UBTI”), including from debt-financed income

• Non-U.S. investors– Concerns regarding U.S. trade or business

effectively connected income (“ECI”) and income subject to U.S. withholding tax

– Investors may be eligible for the benefits of a U.S. tax treaty, resident in a tax haven

Clean Energy Forum:Federal Tax Compliance Issues

For further information on the matters summarized in this outline, please contact one of the following Morgan Lewis attorneys:

Gary B. Wilcox202-739-5509 (Washington, DC office)215-963-5043 (Philadelphia office)gwilcox@morganlewis.com

Wendy C. Unglaub215-963-5281 (Philadelphia office)wunglaub@morganlewis.com