Jun 14, 2011 ... A tax equity investor will receive a return based not only on cash ... Internal
Revenue Code allows a production tax credit (“PTC”) based on the ...
June 14, 2011
TAX INCENTIVES FOR FINANCING RENEWABLE ENERGY PROJECTS A.
APPLICABLE TAX INCENTIVES.
In the United States, most renewable energy projects are financed in part by relying on significant tax incentives available for qualifying renewable energy projects. The federal and state tax incentives can easily provide over 60% of the cost of a qualifying renewable energy project, such as a solar or wind project. Typically, project developers will partner with “tax equity investors” to obtain funding for their projects. A tax equity investor will receive a return based not only on cash flow realized from the project but also federal and state tax benefits associated with renewable energy projects. Tax equity investors are generally large tax-paying entities, such as banks, insurance companies and utilities, who can utilize the tax benefits associated with renewable energy projects. Tax benefits generally arise from two broad categories: tax credits and tax deductions. 1. Federal Tax Credits. The most common federal tax credits in renewable energy projects are the “production tax credit” and “investment tax credit.” Section 45 of the Internal Revenue Code allows a production tax credit (“PTC”) based on the sale of electricity over a 10-year period generated by certain renewable energy projects, such as wind, biomass, geothermal, landfill gas and municipal solid waste.1 Section 48 of the Internal Revenue Code allows an investment tax credit (“ITC”) for certain types of commercial energy projects, including solar, geothermal, fuel cells, and small wind projects equal to either 30% or 10% of the project’s qualify costs, which tax credit is realized in the year that the project is placed in service.2 A taxpayer that has a project that qualifies for both the PTC and ITC may elect to claim either the PTC or ITC but not both. 2. Cash Grant in Lieu of Tax Credits. In 2008, the number of tax equity investors declined dramatically as a result of the severe financial crisis. Consequently, 1
For wind, closed-loop biomass and geothermal power, the PTC is equal to 2.2 cents (adjusted annually for inflation) per kilowatt hour of electricity sold over the 10-year credit period. For other renewable sources, such as municipal solid waste, open-loop biomass and landfill gas, the PTC is equal to 1.1 cents (adjusted annually for inflation) per kilowatt hour of electricity sold over the 10-year period. There are various rules and requirements, such as placed-in-service deadlines, that must be satisfied in order for a project to qualify for PTCs. Solar projects placed in service after 2006 do not qualify for PTCs. 2
A 30% ITC is allowed for solar, fuel cells and small wind projects (≤ 100 kilowatts), and a 10% ITC is allowed for geothermal, microturbines and combined heat and power projects. Like the PTC rules, there are various rules and requirements, including placed-in-service deadlines, that must be satisfied in order for a project to qualify for the ITC.
Section 1603 of the American Recovery & Reinvestment Act of 2009 was enacted in order to create a temporary program allowing a cash grant (the “Cash Grant”) in lieu of tax credits for renewable energy projects. A renewable energy project may obtain the benefits of only one of the PTC, ITC or Cash Grant programs. In today’s environment, most developers select the Cash Grant (in lieu of tax credits) since the developer will receive a lump sum cash payment. The Cash Grant is equal to either 30% or 10% of the qualifying costs of the renewable energy facility depending on the type of renewable energy source. [See Exhibit A.] The U.S. Department of Treasury administers the Section 1603 Cash Grant program, and the Treasury Department will generally issue the Cash Grant within 60 days after the application is filed. Applications generally may only be filed after a project is placed in service. The Cash Grant is excluded from gross income and, consequently, is not subject to federal income tax. However, the tax basis of the facility must be reduced by 50% of the Cash Grant amount, i.e., 15%. Previously, the Section 1603 program was only available for a project when construction of such project was started before December 31, 2010. However, the Tax Relief Act of 2010 (enacted at the end of 2010) extended the “beginning of construction” requirement until the end of 2011. 3. Accelerated or Bonus Depreciation Tax Deductions. In general, most renewable energy projects are eligible for accelerated depreciation over a relatively short depreciation period. For example, the cost of wind and solar projects are eligible for 5-year MACRS depreciation. Also, a lease of renewable energy assets to a governmental or taxexempt entity will be subject to straight-line depreciation over a longer period not less than 125% of the lease term. In lieu of the normal depreciation rules, the “bonus” depreciation rules allow companies that place certain new equipment into service after September 8, 2010 and before the end of December 2011 or 2012 will be entitled to expense immediately, either 100% or 50%, of the cost of the equipment in the year the equipment is placed into service. The bonus depreciation replaces the normal depreciation that a taxpayer would otherwise have claimed. Equipment that is normally depreciated over five years, such as solar and wind facilities, must be placed into service by the end of 2011 in order to qualify for the 100% bonus depreciation.3 Equipment that is placed in service after 2011 but before the end of 2012 will qualify for 50% bonus depreciation. The 50% bonus depreciation means that half 3
A one-year extension of the placed-in-service date (i.e., before the end of 2012) for the 100% bonus depreciation is allowed for certain transportation property and property with a depreciation recovery period of at least 10 years. Most renewable energy equipment has a depreciation recovery period of less than 10 years.
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the cost is deducted immediately and the balance of the cost is deducted under the normal depreciation rules. If a taxpayer claims the Cash Grant or ITC with respect to a renewable energy project, then such taxpayer will be allowed to depreciate only 85% of the cost of the project since the applicable Cash Grant and ITC rules require the tax basis of the property to be reduced by 50% of the Cash Grant or ITC amount. No basis adjustment is required for projects that claim the PTCs. A taxpayer may opt out of the bonus depreciation, but it cannot choose to claim 50% bonus depreciation in lieu of 100% bonus depreciation. The bonus depreciation can only be claimed on new equipment (with a depreciation class life not greater than 20 years) and cannot be claimed on buildings, land or intangible assets. 4. Example of Federal Tax Incentives Associated with a Solar Project. Assume the cost of solar photovoltaic system is equal to $5 million, which is placed into service before the end of 2011. As an initial matter, the 30% Cash Grant will equal $1.5 million. The depreciable tax basis of the solar system would be reduced to $4.25 million (i.e., 50% of $1.5 million Cash Grant amount). The 100% bonus depreciation in 2011 would equal $4.25 million. The taxpayer may use these tax benefits or monetize both of them through a tax equity investor. For a corporate taxpayer with a 35% federal tax rate, assuming it has sufficient income to offset, the tax savings in 2011 from the bonus depreciation would equal approximately $1.5 million (i.e., $4.25 million * 35% tax rate). Of the $5 million in total project costs, approximately $3 million (or 60% of the total cost) is recoverable in 2011, the first year the solar project is placed into service. 5. State Tax Incentives and REC Payments. In addition, many states offer a wide variety of significant incentives to encourage the installation of renewable energy projects, ranging from tax credits, cash grants, performance based incentives, loan programs and sales and property tax exemptions. In addition, approximately 30 states have renewable portfolio standards, which require utilities to obtain a certain percentage of their electricity from renewable energy sources, such as solar and wind. Utilities in these states will pay for the RECs, which can be a significant source of cash flow for renewable energy projects.
B.
SECTION 1603 CASH GRANT REQUIREMENTS.
Since 2009, the Treasury Department has paid over $7 billion in Cash Grants to over 8,000 renewable energy projects. The Cash Grant program has been a tremendous success and is probably the single most important program driving the growth of renewable energy projects since 2009. However, in order to claim the Cash Grant, time is of the essence. As described below, the construction of the renewable energy project must commence before the end of 2011 (unless extended by Congress). The following discussion summarizes the requirements for claiming the Cash Grant:
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1. Qualified Renewable Energy Facility. The power facility must generate electricity from specified renewable energy sources, such as wind, solar, biomass, geothermal and municipal solid waste. The specified energy sources and applicable Cash Grant percentages are set forth on the table attached hereto as Exhibit A. 2. Placed-in-Service Deadline. A qualified facility must be placed in service no later than the end of 2012 (large wind projects), 2013 (biomass, geothermal, landfill gas and waste-to-energy facilities) or 2016 (solar, small wind, fuel cells). The placed-in-service deadline for each renewable energy source is set forth on the table attached hereto as Exhibit A. 3. Beginning of Construction. Given the timing, the “beginning of construction” requirement is one of the most pressing requirements to satisfy. Construction of the facility must begin before December 31, 2011. An applicant must demonstrate that it started “physical work of a significant nature” before the end of 2011, and it may prove this by either (1) commencing significant construction activities with respect to the qualifying equipment and engaging in continuous construction until the project is complete, or (2) by satisfying a safe harbor under which the applicant must show that it paid or incurred at least 5% of the total project cost for qualifying equipment before the end of 2011. In either case, if the applicant uses third persons to perform the work, the work must be performed pursuant to a “binding written contract” entered into prior to the time that the work is performed. 4 Physical work of significant nature can occur on-site, such as foundations, concrete pads for wind turbines, concrete pedestals for solar arrays, or offsite, such as the construction of turbines or photovoltaic panels pursuant to a binding written contract with the manufacturer. Costs are generally not incurred under the 5% safe harbor for accrual taxpayers until equipment or services ordered under a binding written contract are delivered. However, a payment in 2011 counts as a 2011 cost if the equipment ordered is delivered within 3½ months of the payment date. A developer relying on the 5% safe harbor may also include the costs that a contractor or equipment manufacturer incurs with whom the developer has a binding written contract (with no double counting of costs). 4. Applicant Eligibility. Most taxpayers are eligible to receive the Section 1603 cash grant; however, governmental and other tax-exempt entities are ineligible recipients. As a result, municipalities, schools and other tax-exempt entities cannot qualify for the Cash Grant if they directly own the renewable energy project. In such cases, an investor or developer will own the renewable energy project (and claim the Cash Grant and depreciation benefits), and such investor or developer will either (i) lease the project to the tax-exempt entity or (ii) operate the project and sell power to the tax-exempt entity. The tax-exempt entity will indirectly benefit from the Cash Grant and depreciation tax benefits through 4
A binding written contract must be enforceable under state law, and the contract terms cannot limit damages in the event of breach to less than 5% of the total contract price.
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reduced rental rates in the case of a lease or reduced electricity rates in the case of sale of power. 5. Original Use. The original use of the facility must begin with the applicant, i.e., the facility may not have been previously placed into service by another taxpayer. A facility may contain used parts and equipment provided that the used parts and equipment do not exceed 20% of the total cost of the facility. 6. Eligible Costs. In general, the costs of tangible property (not including a building) that is an integral part of the facility will qualify. For example, paved parking lots solely for employee and visitor vehicle traffic are not an integral part of the facility. Qualifying equipment includes generators, power conditioning equipment and any other equipment used for the production of electricity. Qualified property does not include any electrical transmission equipment. 7. Location of Facility. The facility may not be physically located outside the United States. 8. Recapture of Cash Grant. A recapture event generally occurs if the applicant (a) disposes of the qualified facility to a disqualified person (such as a governmental entity or tax-exempt organization) or (b) ceases to use the facility as a qualified facility for the production of electricity within five years after the facility is placed in service. Temporary cessation of energy production will not result in recapture provided that the owner intends to resume production. If a recapture event occurs, then the Cash Grant payment must be repaid to the Treasury Department as follows: (i) 100% of the payment if the recapture event occurs in the first year, and (ii) decreasing by 20% each year depending when the recapture event occurs until the fifth year. Additional information regarding the Cash Grant program can be found at Treasury’s website at http://www.treasury.gov/initiatives/recovery/Pages/1603.aspx.
C.
COMMON OWNERSHIP STRUCTURES.
A developer/taxpayer could simply own a renewable energy facility and claim the applicable tax credits or Cash Grant and depreciation deductions on its tax returns. To the extent funding is needed from a third-party, the following are two common ownership structures: 1. Partnership Flip Structure. A pass-through entity, such as a partnership or limited liability company, would own the facility and allocate the tax credits (or Cash Grant) and depreciation among its partners, including a tax-equity investor. Upon investment, the tax-equity investor is generally allocated up to 99% of the tax credits and depreciation 5
benefits and the remaining 1% is allocated to the developer. After the tax-equity investor has received its agreed-upon return (via tax allocations and cash distributions), the partnership interests would flip so that the developer would have a much larger percentage, as much as 95%, and the tax equity investor would have a 5% interest. In most cases, after the partnership flip, the developer will purchase the investor’s 5% interest. 2. Sale/Leaseback Structure. The developer could sell the facility to an investor and lease it back, allowing the investor to claim the Cash Grant (or tax credits) and depreciation. The lessee would operate the renewable energy facility and use or collect revenue from the sale of electricity. This sale/leaseback structure works well with governmental entities and other tax-exempt entities since these entities cannot claim the Cash Grant and do not benefit from the depreciation deductions. For example, a developer or an investor could own the facility and lease it to a tax-exempt entity in exchange for rental payments. At the end of the lease term, the lessee generally will have the right to purchase the facility at fair market value. For more information, please contact: Bill Ewing, Partner- Atlanta office
[email protected] 404-264-4050 © 2011 Barnes & Thornburg LLP. All Rights Reserved. This summary is proprietary and the property of Barnes & Thornburg LLP. It may not be reproduced, in any form, without the express written consent of Barnes & Thornburg. This Barnes & Thornburg LLP publication should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own lawyer on any specific legal questions you may have concerning your situation.
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EXHIBIT A Specified Energy Property
Placed-in-Service Deadline
Applicable Cash Grant Percentage
Large Wind (> 100 kilowatts)
Dec 31, 2012
30%
Closed-Loop Biomass Facility
Dec 31, 2013
30%
Open-Loop Biomass Facility
Dec 31, 2013
30%
Geothermal (IRC § 45)
Dec 31, 2013
30%
Landfill Gas Facility
Dec 31, 2013
30%
Trash Facility
Dec 31, 2013
30%
Qualified Hydropower Facility
Dec 31, 2013
30%
Marine & Hydrokinetic
Dec 31, 2013
30%
Solar
Dec 31, 2016
30%
Geothermal (IRC § 48)
Dec 31, 2016
10%*
Fuel Cells
Dec 31, 2016
30%**
Microturbines
Dec 31, 2016
10%***
Combined Heat & Power
Dec 31, 2016
10%
Small Wind (≤ 100 kilowatts)
Dec 31, 2016
30%
Geothermal Heat Pumps
Dec 31, 2016
10%
* Geothermal property that meets the definitions of qualified property in both § 45 and § 48 is allowed either the 30% credit or the 10% credit but not both. ** For fuel cell property, the maximum amount of the payment may not exceed an amount equal to $1,500 or each 0.5 kilowatt of capacity. *** For microturbine property, the maximum amount of the payment may not exceed an amount equal to $200 for each kilowatt capacity. 7
