III. The IRS Listens: Announcement 2009-69
A. Revisions to Rev. Proc. 2007-65
The IRS heard the cries of taxpayers and published Announcement 2009-69 to make three significant revisions to Rev. Proc. 2007-65. First, the announcement removes the ‘‘closely scrutinized’’ language from the revenue procedure. The revised language merely states that ‘‘returns claiming wind energy tax credits under [section] 45 are subject to examination by the Service.’’ (A corresponding change is made to the example in the revenue procedure to clarify that effect on transactions that do not satisfy the safe harbor.)
Second, the announcement removes the requirement that the price of the call option must be set at the project’s FMV at the time the option is exercised. According to the revised language, the contractual right to purchase must satisfy the requirements of section 4.05 of Rev. Proc. 2007-65,103 and the right must be ‘‘negotiated for valid non-tax business reasons at arm’s length by parties with material adverse interests.’’ Also, the purchase price may be determined before the exercise of the right, but must be ‘‘a price that the parties reasonably believe, based on all the facts and circumstances at the time the price is determined, will not be less than the fair market value of the property at the time the right may be exercised.’’ Thus, the announcement allows parties to a partnership flip transaction to use a purchase price determined at the time the partnership was created, but the price must reflect a reasonable determination of the FMV of the investor’s partnership interest at the time of exercise. As discussed, a buyout option that could be exercised at less than FMV has passed muster with the courts and the IRS, so it would appear the current pricing requirement is unnecessary for the safe harbor. However, the current language was suggested by comment letters, and pricing in this manner is consistent with industry practice.
Third, the announcement changes the rules pertaining to investors that are subject to the passive activity laws. Under the original language in Rev. Proc. 2007-65, only entities not subject to the passive activity laws under section 469 could offset non project income with the PTC. Under Announcement 2009-69, a taxpayer subject to section 469 may use the PTC to offset regular tax liabilities associated with passive investments. Specifically, passive investors can claim PTCs ‘‘only to the extent of their tax liability allocable to the passive activities, whether from qualified wind facilities or other sources.’’ In other words, taxpayers subject to section 469 are not limited to using PTCs to offset wind project passive activity income; those taxpayers can also offset income from other passive activities with the PTC.105
Although Rev. Proc. 2007-65 does not explicitly cover renewable energy projects other than wind farms, tax advisers are looking to the principles in the revenue procedure in evaluating partnership flip transactions involving projects that use other forms of renewable energy (for example, biomass, geothermal, and solar). The IRS is expected to issue guidance that would extend the revenue procedure and the revisions in the announcement to other renewable energy sources.
IV. Epilogue: Congress Fills the Sails
A. Federal Stimulus
Fiscal stimulus provided a forum for Congress to press ahead with its agenda for encouraging energy independence, improving the environmental profile of America’s energy production, and creating jobs
at home. ARRA, enacted in February 2009, included several energy incentives.
Under ARRA, a wind energy developer can make an irrevocable election to claim a 30 percent ITC under section 48 in lieu of the PTC. The election can be made for facilities placed in service from 2009 through 2013 (2012 for wind). Taxpayers electing the ITC over the PTC can receive the entire benefit of the incentive in the year in which the qualified facility is placed in service instead of accruing the tax benefit over 10 years.
ARRA also includes a temporary program that permits wind developers to forgo the PTC or 30 percent ITC in favor of a direct cash grant from the Treasury. The grant generally is equal to 30 percent of the adjusted tax basis of five-year modified accelerated cost recovery system property located at the site. The grant is excluded from gross income, and the basis of the qualified facility is reduced by half of the grant amount received. To qualify for the grant, projects must be placed in service (that is, ready and available for their specific use) after 2008 and before 2013 (for wind specifically), and construction must begin by December 31, 2010.
Property eligible for the grant must not be property predominantly used outside the United States, and the original use of the property must begin with the grant applicant, although used parts may account for up to 20 percent of the cost of the property. Property eligible to receive a grant includes only tangible property that is both used as an integral part of the activity performed by the qualified facility and located at the site of the qualified facility. For electricity generation, the qualified property includes storage devices, power conditioning equipment, transfer equipment, and parts related to the functioning of those items but does not include any electrical transmission equipment or any equipment beyond the electrical transmission stage. The grant program is designed to help revive investment in renewable energy projects by furnishing a federal subsidy that is not limited to investors that are paying federal income tax on a current
The grant program has been popular with wind energy developers and has done much to vitalize the industry by providing easy and inexpensive access to funding. As of August 26, 2010, $5.21 billion in grant money had been distributed to 1,112 renewable energy projects.110 Of those 1,112 projects, 103 (9 percent) were wind projects (excluding small wind projects). Interestingly, a total of $4.45 billion in grant funds has been distributed to wind projects. Thus, although 9 percent of the total successful grant applicants have been wind projects, wind projects have received 85 percent of the total funding distributed to date. The high dollar amount awarded to wind developers is due to the high cost to construct utility-scale wind farms.
Given the three choices available, developers typically will perform a financial analysis to determine which subsidy is most beneficial. The PTC is more valuable for wind projects with a higher projected capacity and lower installation costs (that is, the PTC is based on the amount of electricity generated, while the ITC and Treasury grant are based on installation costs).113 Project developers also have the option of claiming a mix of incentives at each wind farm. The developer can elect the incentive on a turbine-by-turbine basis. For example, a wind farm project could receive an upfront grant to cover part of the installation costs for the project and still receive the PTC for a portion of the electricity production from the project over 10 years.
ARRA also includes a provision that provides a 30 percent ITC for the cost of qualifying investments in a qualifying advanced energy project. Qualifying advanced energy projects include projects that reequip, expand, or establish a manufacturing facility for the production of property designed to be used to produce energy from wind, among other things. The credits were allocated by Treasury and applicants had to submit an application to receive an allocation. The amount of credit available for allocation under section 48C was capped at $2.3 billion; the program was oversubscribed and the entire $2.3 billion was allocated. Of the 183 successful applications, 35 were submitted by manufacturers of wind turbines or the components thereof (for example, blades and towers).
B. Future of Wind
Based on Congress’s practice for nearly 10 years, presumably, the PTC will continue to be extended, although it may undergo changes. For example, a present-value cap of 35 percent of cost on the PTC was proposed in the House version of the Emergency Economic Stabilization Act of 2008.115 The cap was not included in the final version of that act, but such a cap could become part of future legislation.
Another factor that already has affected the wind industry and further emphasizes the need for more creative federal incentives is state-level Renewable Portfolio Standards (RPSs). An RPS generally obligates electricity supply companies to produce a specified fraction of their electricity from renewable energy sources and provides mechanisms that are permitted to achieve compliance, such as renewable energy credits. Currently, 29 states and the District of Columbia have an RPS.
Federal incentives, such as the PTC, have helped the renewable energy industry and especially the wind industry grow and prosper. The PTC’s chief deficiency is that it fails to stimulate use of alternative energy when fossil fuel prices fall below a certain level. The wind industry has pressed for legislation on federal RPS, which would decrease the wind industry’s dependence on high electricity and fossil fuel prices by requiring a specified amount of energy to be produced from renewable sources. The House has passed legislation that includes a federal RPS, but the Senate has not put the issue to vote. The wind industry sees the enactment of a federal RPS as crucial to its long-term future, and indeed to the future of the renewable industry as a whole. That legislation would further secure the status of the wind industry as an indispensable part of America’s energy future.