In a recent case, the Tax Court ruled in the taxpayer’s favor as to three California distributed generation solar projects’ eligibility for the energy credit under Section 48 and bonus depreciation under Section 168.  However, the Tax Court did reduce the taxpayer’s basis in the projects, and the taxpayer in the case enjoyed significant procedural advantages due to mistakes by the IRS.

In Golan v. Commissioner, T.C. Memo. 2018-76 (June 5, 2018), in late 2010 a solar contractor installed solar equipment on the roofs of three host properties and entered into power purchase agreements (“PPAs”) with the property owners.  The PPAs provided that the hosts would purchase electricity generated by the solar equipment at a discount to utility rates, while the solar contractor would retain the ownership of the equipment, including the right to any tax or other financial benefits, and would service and repair the equipment.

Mr. Golan, the taxpayer, in 2011 purchased the solar equipment, subject to the PPAs, from the solar contractor for a purported purchase price of $300,000, which was the sum of a purported $90,000 down payment, a $57,750 credit for certain rebates, and a $152,250 promissory note (which the taxpayer was the obligor under but the taxpayer also provided a personal guarantee thereof).  The solar projects were not connected to the grid until after the taxpayer acquired them in 2011.  The IRS unsuccessfully sought to disallow the taxpayer from taking energy credit and depreciation deduction with respect to the solar equipment.

Before we discuss the substantive holdings in this case, it is important to note that the holdings were based in large part on the IRS, unusually, having the burden of proof.  Generally, taxpayers bear the burden of proof; however, the IRS in the notice of deficiency that was generated after the conclusion of the audit of the taxpayer, failed to properly raise the issues in the case.  For instance, the notice of deficiency provided that the taxpayer’s expenses did not qualify for the “Rehabilitation Credit” under Section 47 or expensing of business assets under Section 179; thus, missing that the tax credit in question was the energy credit under Section 48, and the deductions in question arose under Section 168(k) (bonus depreciation).  These mistakes were fortuitous for the taxpayer as they shifted the burden of proof to the IRS with respect to the actual issues in the case.

The atypical procedural posture means that taxpayers need to be cautious in how much weight they place on the case as precedential value as the results could have easily been different if the taxpayer had to shoulder the burden of proof.  Similarly to the Claims Court’s opinion in the cash grant case Alta Wind, which we discussed in a prior post, Golan is an example of the critical significance of a case’s procedural posture.

The Tax Court’s ruling included five opinions of note:

First, the taxpayer’s basis in the solar equipment for the year in question was reduced from $300,000 to $152,250.  The basis reduction was the result of two adjustments.  First, the taxpayer paid none of the $90,000 down payment in 2011 because the taxpayer did not pay anything towards the down payment during that year and even in later years only paid $80,000 of the $90,000 purported amount.

Further, the Tax Court properly concluded that the taxpayer was not entitled to basis for the $57,750 in utility rebates that were assigned to the solar contractor: “Mr. Golan neither received nor reported the rebates as income.  We therefore find on the record before us the credit was really a purchase price reduction … and never recognized as taxable income by the taxpayer.”

Second, the taxpayer satisfied the requirements of Section 168(k)(5) bonus depreciation, which at that time required the taxpayer to be the “original user” of the personal property for it to be eligible.  The IRS argued that the solar projects were placed in service by the solar contract, prior to their purchase by the taxpayer, even though the projects were not connected to the grid until after the taxpayer owned them.  The Tax Court did not apply the five-factor placed-in-service test that IRS rulings apply to power projects.[1] Rather, it simply held that “the solar equipment was not ready and available for full operation on a regular basis for its intended use until it was connected to the electric grid.  [W]e hold that [the taxpayer] placed the solar equipment in service in 2011” when the interconnection with the grid occurred.

Interestingly, the IRS used the placed-in-service argument to attack the bonus depreciation eligibility, but seemed to miss the fact that if the projects were placed in service before the taxpayer’s acquisition, then there was no energy credit as that statute also has a requirement “that original use of such property commences with the taxpayer.”[2]

Third, the taxpayer was “at risk” under Section 465 with respect to the promissory note for depreciation purposes.  The Tax Court rejected the IRS’s argument that the solar contractor, as the lender under the promissory note, had a prohibited continuing interest in the projects.  The court reasoned that the solar contractor was not entitled to any assets of the projects upon a liquidation and had only permitted gross receipts interest, not the prohibited “net profits” interests, in the projects.  The opinion provides, “To be sure, the promissory note requires [the taxpayer] to pay [the solar contractor] all monthly revenue generated by the solar equipment.  However, [the solar contractor’s] right to all monthly revenue is a gross receipts interest, which the regulations permit.”

An interesting nuance, is that the Tax Court appeared to have little concern that the promissory note was “a ‘cash flow’ instrument, the note had maturity date [in 2041], but did not have fixed payment amount.  Instead it required Mr. Golan to pay towards the note all monthly revenue generated by the solar equipment.”  Presumably, Mr. Golan was personally liable on the remaining balance of the note in 2041 when the note “matures,” but that is not specifically addressed in the opinion.  Given the failure of Mr. Golan to pay the down payment in 2011 and the cash flow limitation in the note, the IRS seems to have possibly missed the argument that the solar contractor was the owner of the projects in 2011 when they were placed in service.

Further, the Tax Court commented in a footnote that the taxpayer “granted [the solar contractor] an option to purchase the solar equipment for the outstanding balance of the promissory note” after the five-year tax credit recapture period.  If the projects performed well, the balance of the note in five years could have been paid down to a modest level.  That balance could well be less than the fair market value of the projects at that time.  Thus, the solar contractor could have been the beneficiary of a bargain or compelled purchase option to acquire the projects from the taxpayer.  That would have been a further indication that the solar contractor, not the taxpayer, was the owner of the projects.  However, the opinion provides “[n]either party mentioned this agreement at trial or on brief.”

Fourth, the taxpayer was not subject to the Section 469 passive activity loss limitations with respect to the projects.  The Tax Court found the taxpayer’s testimony credible and held the taxpayer spent more than 100 hours on the projects during the year in question and no other person spent more time than that.  The IRS had the burden of proof on that issue.  There is no explanation as to what the taxpayer did to achieve the 100 hours.[3]  However, it is comforting to know that in concept an individual can meet the 100 hours requirement in a solar PPA deal.

Lastly, no accuracy-related penalty was imposed on the taxpayer, even on the unpaid down payment that taxpayer claimed to be part of the projects’ basis.  The Tax Court’s rationale for not imposing penalties was that the taxpayer reasonably relied on the CPA that prepared his return.  This conclusion as to reasonable reliance on the CPA seems lenient to us because for a taxpayer to avoid penalties based on professional advice, the “advice must not be based upon a representation or assumption which the taxpayer knows, or has reason to now, is unlikely to be true.”[4]

The only explanation as to how the CPA included the unpaid down payment in 2011 in the taxpayer’s basis is that either the taxpayer represented to the CPA that he paid the down payment in 2011 when the taxpayer knew he did not or the CPA failed to request such confirmation.  Thus, either the taxpayer made a representation he knew was untrue or the CPA missed such an obvious issue that he was not qualified to prepare the return.  Either way, in the abstract, it seems like this would have been an appropriate instance for understatement penalties to apply.

[1] See, e.g., Rev. Rul. 76-256; P.LR. 201326008 (Jun. 28, 2013); P.L.R. 201326009 (Jun. 28, 2013).

 

[2] I.R.C. § 48(a)(3)(B)(ii).  There is an exception for sale-leasebacks within three-months of the placed in service date.  I.R.C. § 50(d)(4).

[3] For an example of the detailed evidence required to document 100 hours of work in a taxable year, see our blog post discussing the Tax Court’s opinion in Leland v. Commissioner, T.C. Memo 2015-240.

[4] Treas. Reg. § 1. 6664-4(c)(ii).

Below are soundbites from panelists at Infocast’s Solar Power Finance & Investment Summit from March 19th to 22nd in Carlsbad, CA.  It was an extremely well-attended event and the mood of the participants was generally upbeat.  Many people observed that there was more capital for projects under development or to buy operating portfolios than there was such supply of projects available to meet that demand.

The soundbites are edited for clarity and are organized by topic, rather than in chronological order.  They were prepared without the benefit of a transcript or recording.

Impact of Tax Reform on the Tax Equity Market

Impact of the Corporate Tax Rate Reduction on the Supply of Tax Equity, Yields and the Capital Stack

“This year we can do $9 million in tax credits; before we could do $15 million.”  [The implication is that a 21 percent federal corporate tax rate is 40 percent less than a 35 percent corporate tax rate, so the tax appetite has declined by 40 percent.]  Vice President, Industrial Bank

“The [supply side of the] tax equity market has declined by 40 percent; some tax equity investors are taking a pause.”  Vice President, Regional Bank

“Our bank this year is slightly below the billion dollars of tax equity it originated last year for its own book.” Vice President, Midwestern Bank

Some “mainstream tax equity investors have taken a pause [from investing] to figure out what the 21 percent corporate tax rate means for them.  It is an investors’ market, but we nervously see a sponsors’ market ahead.”  Managing Director, Financial Advisory Firm

Traditionally, rates for tax equity have been a function of supply and demand, but now we are seeing real pressure on rates.”  Managing Director, Money Center Bank

[It is difficult to jibe this banker’s quote regarding pressure on tax equity rates with the quotes above regarding the supply of the tax equity market being smaller due to tax reform.  Possibly, tax equity investors are agreeing to share some of the yield detriment of the depreciation being less valuable and that has resulted in reduced after-tax yields.]

“Some utilities that had tax appetite no longer have tax appetite and need to raise tax equity for their projects.”  Director, Money Center Bank

“We are trying to get back to the same all-in return where we were before tax reform.”  [As the depreciation is less valuable at a 21 percent tax rate than it was at a 35 percent tax rate, this means either (i) contributing less for the same 99 percent allocation of the investment tax credit or (ii) contributing the same amount and requiring a distribution of a larger share of the cash.]  Vice President, Midwestern Bank

“Tax reform helped us because it means tax equity contributes less to the project, so it makes our loan product more necessary.” General Manager Renewable Energy Finance, Small Business Bank

“The debt market has come in and is filling the decline in tax equity.” Executive Director, Manufacturing Corporation

“The buyouts of [tax equity investors’ post-flip interests] are more valuable because of the lower tax rate.”  Partner, Big 4 Firm

“We see sponsors’ financial returns over a 35-year project life increase due to the tax rate reduction.”  ” Managing Director, Structuring Advisory Firm Continue Reading Infocast’s 2018 Solar Power Finance & Investment Summit Soundbites

In a recently released private letter ruling (available here), the IRS confirmed that residential solar energy batteries are eligible for the tax credit under Section 25D of the Code (the “Residential Solar Credit”), subject to an important and unexpected caveat.

In Priv. Ltr. Rul. 2018-03-009 (Mar. 2, 2018) (the “PLR”), the taxpayers had previously installed a solar energy system on their home and claimed the Residential Solar Credit.  The taxpayers were now purchasing a battery to integrate into their existing solar energy system.  The battery was designed such that charging would only occur when the solar energy system was producing energy and only up to the instantaneous solar power, thereby ensuring that all energy that was used to charge the battery would come from the solar energy system. The remaining useful life of the solar energy system was expected to exceed the useful life of the battery.  The taxpayers posed two questions to the IRS: (1) Is the battery a type of property that is eligible for the Residential Solar Credit and, if so, (2) will the battery remain eligible for the Residential Solar Credit even though it was installed subsequent to the year in which the solar energy system was installed. Continue Reading Residential Solar Storage is Eligible for Tax Credit, Subject to a 100% Cliff

Pratt’s Energy Law Report has published our article 2018 and Onward: The Impact of Tax Reform on the Renewable Energy Market. We are pleased to be able to make a PDF version of the article available.  (The article starts on page 6 of the PDF).

The Bipartisan Budget Act of 2018 (H.R. 1892) (the “Act”) was enacted on February 9, 2018.  The Act is a two-year budget agreement that includes a number of provisions extending lapsed renewable energy-related tax credits; however, the Act does not change the amount or timing of the tax credits for utility scale wind or for solar.

The Act retroactively renews the tax credits for the so-called orphaned technologies that were left out of the 2015 extension for wind and solar, but for some of the orphaned technologies the tax credits are only available for projects that started construction prior to 2018; thus, limiting the tax planning opportunities, while rewarding bold developers that started construction in 2017 while the credits were lapsed.

Excise tax matters and energy related tax credits for homes, buildings, vehicles, nuclear power plants, Indian coal, biodiesel and biofuel are beyond the scope of this blog post. Continue Reading Bipartisan Budget Act Partially Reinstates Orphaned Energy Tax Credits

The Equipment Leasing and Finance Association has published our article The Impact of Tax Reform: What Leasing Companies Need to Know (subscription required).  We are also pleased to be able to make the article available in PDF format.  The article addresses equipment leasing generally, rather than being renewables or tax credit focused.

A Word About Wind has published our article What Is the Impact of Tax Reform on US Wind Tax Equity Deals? in its blog (subscription required) and newsletter.  If you are unable to open the blog post, the text of the article is available below:

On 22 December 2017, President Trump signed the first major reform of the United States tax code since 1986. Here are some of the ramifications of the reforms on wind tax equity transactions.

Corporate Tax Rate Reduced to 21%

In 2018, the corporate tax rate has been reduced from 35% to 21%. The rate reduction means that US corporations will pay significantly less federal income tax, so the supply of tax equity will decline. However, most tax equity investors are expected to still pay enough tax to merit making tax equity investments.

Importantly, the rate reduction means sponsors of wind projects will be able to raise less tax equity as depreciation deductions are worth only $.21 per dollar of deduction rather than $.35 per dollar.

100% Bonus Depreciation

A partial mitigant to tax rate reduction is that the act provides the option of claiming 100% bonus depreciation (i.e. expensing), so depreciation deductions can be available in the first year (rather than over multiple years). However, the partnership tax accounting rules hamper the efficient use of 100% bonus depreciation. Continue Reading What Is the Impact of Tax Reform on US Wind Tax Equity Deals?

On December 22, 2017, the president signed the tax reform bill.  It is generally identical to the conference committee bill discussed in our blog post of December 19, and specifically there were no changes with respect to renewable energy, corporate income taxes, partnerships or expensing.  Therefore, our analysis of the conference committee bill holds true for the enacted bill.

The changes that were made to the bill were minor and were required by the Senate’s parliamentarian to comply with the “Byrd rule” in order for the bill to be passed with only a simple majority of the votes in the Senate.  First, the parliamentarian objected to the “short title” of the bill being “Tax Cuts and Jobs Act.”  The enacted bill does not have a “short title”, so it is being colloquially referred to as the act formerly known as the Tax Cuts and Jobs Act.  The parliamentarian’s other two objections related to aspects of the new tax on large endowments of colleges and universities and changes to the section 529 tuition reimbursement account program.

I suspect that as the act is studied by tax professionals that traps for the unwary, unexpected planning opportunities and technical glitches will be identified.  To the extent they relate to the renewable energy industry, they will be covered in this blog.

Today, the House voted 227 to 303 in favor of the tax reform bill agreed to by the conference committee.  No Democrats voted for the House bill, and 12 Republicans from high tax states voted against it.  The Senate is expected to vote later this evening to approve it; it is possible that the president could sign the bill as early as tomorrow.

The enacted legislation is expected to be identical to the bill approved by the conference committee.  Our analysis of the conference committee’s bill’s impact on the renewable energy market is below, which is followed by a chart that summarizes the relevant provisions in each of the three bills. Continue Reading House Passes Tax Reform & the Impact of Tax Reform on the Renewable Energy Market