Tax Incentives for Renewable Energy Investments Under the American Recovery and Reinvestment Act of 2009 ( ARRA )

Transcription

1 Tax Incentives for Renewable Energy Investments Under the American Recovery and Reinvestment Act of 2009 ( ARRA ) March 18, 2009 Copyright 2009 Shearman & Sterling LLP. As used herein Shearman & Sterling refers to Shearman & Sterling LLP, a limited liability partnership organized under the laws of the State of Delaware. Attorney Advertising.

2 Renewable Energy Has Won the Federal Tax Lottery ARRA provides almost $15 billion of incentives for renewable energy investments. Incentives include a veritable smorgasbord of tax benefits and direct subsidies. 1

3 Benefits Available Tax Benefits Fifty Percent Bonus Depreciation (if placed in service in 2009) MACRS Depreciation Production Tax Credits ( PTC ) (annual credit for electricity sold to third parties) Investment Tax Credit ( ITC ) (30% of cost, available only if owner forgoes PTC) Direct Grants for those investors without a tax base Direct grant mirrors 30% ITC (available only if owner forgoes both ITC and PTC) 2

4 Benefits Available Bonus Depreciation First-Year Deduction of 50% of tax basis No half-year or mid-quarter convention applicable Not reduced for short tax year Project qualifies if Original use commences with the taxpayer before January 1, 2010 (or pursuant to binding written contract entered after December 31, 2007 and before January 1, 2010) or Placed in service in 2010 for certain longer-lived property and transportation property 3

5 Benefits Available Bonus Depreciation (cont.) Available to tax owner of project Direct owners Partners Lessors Lessor may claim bonus depreciation if sale leaseback within 3 months of original in-service date Additional 3 months to syndicate equity if lessee does not change 4

6 Benefits Available MACRS Depreciation Typically 5 year MACRS for domestic Renewable Energy Property Double Declining Balance Half-year convention Available to tax owner of project Direct owners Partners Lessors 5

7 Benefits Available Depreciation Bonus Depreciation plus 5 year MACRS Depreciation can generate a first-year deduction of up to 60% of depreciable basis. 6

8 Benefits Available Alternative Depreciation Taxpayer may forgo Bonus Depreciation and MACRS Depreciation May elect Alternative Depreciation System For most renewable energy projects, 12-year straight line depreciation May mitigate alternative tax net operating loss deduction limitations if owner cannot use depreciation currently 7

9 Benefits Available Production Tax Credit Tax Credit for production and sale to third parties of energy from specified renewable energy projects Credit available for kwh produced by qualified facilities and sold to unrelated parties in the first five or ten years of operation, depending on the resource Credit rate varies Starts at 1.51 per kwh, adjusted for inflation, reduced for different resources and reduced as the market price for electricity from comparable resources exceeds 8 (also inflation adjusted) Generally only available to taxpayer who is the owner and operator of facility Leasing allowed for open loop biomass and certain closed loop biomass expansions Credit reduction for subsidized energy financing eliminated 8

10 Production Tax Credit Qualifying Resources Wind Closed loop biomass Open loop biomass Geothermal Solar Landfill gas Municipal solid waste Qualified hydropower Marine and hydrokinetic Required in-service date extended through 2012 for wind and 2013 for most others 9

11 Investment Tax Credit Back to the Future Credit against tax for 30% of investment in specified renewable projects that would qualify for PTCs Credit is available to tax owner that is original user Lessor is treated as original user if sale leaseback within 3 months of original use Credit may be passed through to lessee No basis reduction for lessor but lessee has income inclusion equal to basis reduction over recovery period (5 years) Credit equals 30% of basis in qualifying property, or Qualifying property must be tangible personal property Other tangible property used as an integral part of qualified facility No buildings or structural components Must be depreciable property Depreciable basis is reduced by 50% of credit or 15% 10

12 Investment Tax Credit Back to the Future Credit carries back 1 year and forward 20 years Progress expenditure credit available for projects with construction period 2 years or longer Projects must be domestic, cannot be used by governments, taxexempt entities (except in unrelated trades or businesses) or foreign persons not subject to U.S. tax Must be placed in service before January 1, 2013 (wind) or January 1, 2014 (other resources) ITC is in lieu of PTCs 11

13 Investment Tax Credit Back to the Future (cont.) New ITC incorporates many rules of pre-1986 ITC Large body of law and IRS interpretation on many important issues Many pre-1986 rules explicitly made applicable to new ITC were removed from IRC in 1990, but were not actually repealed Clients need pre-1986 lawyers 12

14 Benefits Available Direct Grant for Renewable Projects The Treasury will provide a direct 30% grant in lieu of the 30% ITC Grant is based on ITC criteria Tangible personal property, other tangible property used as an integral part of qualifying facility, must be depreciable property No buildings or structural components Grant is intended to mimic operation of new ITC 13

15 Benefits Available Direct Grant for Renewable Projects (cont.) Available to person entitled to credit Presumably lessor or lessee in a lease Available for property placed in service in 2009 or 2010 If construction commenced in 2009 or 2010, must be placed in service before 2013 (wind) or 2014 (other renewables eligible for ITC) Payable within 60 days of later of date of application or in-service date of asset Grant application must be received before October 1, 2011 Depreciable basis is reduced by 50% of grant or 15% Grant is not taxable income 14

16 Benefits Available Depreciation Plus ITC or Grant For a project placed in service in 2009, the first year federal tax benefits can equal almost 50% of depreciable cost 30% ITC or grant Bonus depreciation plus MACRS depreciation equal to 51% (60% x 85% basis) x 35% federal tax rate = 17.85% 15

17 Recapture ITC and Grants If the facility ceases to operate, or is sold or exchanged, within five years of first being placed in service, the ITC or grant is recaptured 100% recapture if disposition in 1st year of operation 80% if disposition in 2nd year; 60% if disposition in 3rd year; 40% if disposition in 4th year; 20% if disposition in 5th year Recapture is triggered when the sole owner of a disregarded entity that owns the facility sells LLC If the credit has been allowed to a consolidated group, recapture is triggered if the facility leaves the group Recapture is triggered by the reduction of a partner s interest in the profits derived from the facility below 2/3 of what that interest was for the year when the facility was placed in service No recapture is triggered by any transaction to which section 381(a) of the Code applies 16

18 Investment Structures for Utilizing Tax Benefits and Grants Basic structures for utilizing renewable tax benefits include Partnerships Leases 17

19 Investment Structures Partnerships Partnerships are pass-through entities for federal income tax purposes tax benefits including depreciation and tax credits passthrough to partners Allows multiple unrelated participants Allows flexibility in allocating taxable income, cash and tax benefits Allocations must satisfy rules for substantial economic effect set forth in Treasury Regulations PTCs follow allocation of electricity receipts ITC follows allocation of taxable income of partnership IRS safe harbor for Wind PTC partnership 18

20 IRS Safe Harbor for Wind PTC Safe harbor established by IRS in Rev. Proc requires all of the following: 1. Each investor partner must have an interest in each material item of partnership income and gain equal to at least 5% of that partner s highest percentage interest in partnership income and gain for any year. 2. The developer partner must have at least a 1% interest in each material item of partnership income, gain, loss, deduction and credit during the entire life of the partnership. 3. Each investor partner must make a minimum unconditional at-risk investment at the on-source date of the project or upon acquisition of its investment that is at least 20% of such investors total reasonably expected contributions the partner cannot be guaranteed a return of this portion of its contribution, directly or indirectly, by another partner, the turbine supplier or the power purchaser or any party related thereto. 19

21 IRS Safe Harbor for Wind PTC (cont.) 4. At least 75% of the contributions reasonably expected to be made by each investor partner must be fixed obligations of the partner, not contingent. 5. The partners and their related parties must not have an option to buy a partnership interest or the project (any of its assets) at a price that is less than FMV at the time the option is exercised. 6. The developer must not have the right to exercise any option to buy the project entire, or an interest in the partnership, during the first five years after the facility is placed in service. 7. The partnership must never have an option to put the project (or any of its assets, excluding electricity) to any person. 8. No investor partner can have the right to put its partnership interest to any person. 20

22 IRS Safe Harbor for Wind PTC (cont.) 9. There must be no guarantee, by any person, of an investor partner s right to use any credits. 10. A guarantee for the benefit of the partnership regarding wind resource availability is permitted if provided by a third party unrelated to (i) the partners, (ii) the turbine supplier, (iii) any power purchaser, and (iv) any other project participant ; provided, however, that the partnership and/or a credit-using partner directly pays the cost of such guarantee. A take-or-pay contract regarding electricity produced by the project is a guarantee for these purposes. 11. The developer cannot provide funds or guarantees to an investor partner for the acquisition of its partnership interest. 12. The credits must be allocated in accordance with the partners interests in gross receipts from the sale of electricity as of the time the tax credit arises. 21

23 IRS Safe Harbor for Wind PTC (cont.) Developer Lenders PTC Investors $15x $50x - $10x upfront $100x Wind Turbines Cash Developer Gross Income/ Loss & PTC Cash Investors Gross Income/ Loss & PTC Period Ends At end of period 2 Developer has option to acquire investor s interest for FMV Period 1 100% 1% 0% 99% Earlier of return to Developer of $15x or fixed date Period 2 0% 1% 100% 99% Investor achieves after-tax return Period 3 95% 95% 5% 5% Remaining life of project 22

24 Investment Structures Leveraged Leases Leveraged leases have historically been viewed as an acceptable method for transferring tax attributes of ownership IRS Leasing Guidelines outstanding since 1975 Leasing has been utilized to transfer ITCs prior to ITC repeal in 1986 Specific rules allowing ITC pass through to lessee Specific rules allowing sale leasebacks within 3 months of in service without loss of ITC There is a significant body of tax law surrounding leasing LILOS, SILOS and other cross-border leasing has generated adverse publicity, legislation and case law Nevertheless, IRS Leasing Guidelines remain outstanding and useful in structuring deals Specific rules relating to ITC 23

25 Leveraged Leases Leasing Guidelines Rev. Proc restates the historical Guidelines of Rev. Proc , providing a safe-harbor for advanced ruling purposes. These guidelines require: 1. A minimum unconditional at-risk equity investment equal to at least 20% asset cost, which must be maintained throughout the lease term. 2. A residual value at the end of the base lease term (plus any fixed rate renewals) of at least 20% of the original asset cost, calculated without considering inflation. 3. A remaining useful life at the end of the base term (plus any fixed rate renewals) equal to the longer of one year or 20% of the originally estimated useful life of the property. 4. No lessee purchase option at less than fair market value at the time the right is exercised. 24

26 Leveraged Leases Leasing Guidelines (cont.) 5. No lessor put or abandonment rights. 6. Limitations on lessee improvements to the property. 7. No lessee debt or loan guarantees. 8. The lessor must expect to receive a pre-tax profit from the transaction, apart from the value of tax deductions, allowances, credits, and other tax attributes. In determining whether the lessor expects to receive an overall profit, the indirect costs of financing the lessor s equity investment may be ignored, and the expected residual value may be considered. Lessor must also expect positive cash flow over the life of the lease. Typically, this amount has been in the range of 2-4%. 9. The property cannot be limited use property. 25

27 Investment Structures Leveraged Lease Equity Investor Lender $ + Tax Benefits At least 20% Lessor Grantor Trust Debt Service No more than 80% ITC/grant either claimed by equity investor or lessee $ Purchase Price $ Rent Lessee 26

28 Issues for Investment Structures Using ITC or Grants Economic Substance Is a pre-tax profit required? Case law suggests pre-tax profit not required for energy ITC IRS rulings and wind partnership safe-harbor suggests not required for PTCs No law or specific guidance in new law for grant Will PTC safe harbor constraints be applied to ITC? Fixed price purchase options, EBOs? Use of Section 467 rent prepayments? Should IRS/Treasury guidance be sought? Future of leveraged lease accounting? 27

29 Cross Border Considerations

30 General U.S. Tax Considerations Various U.S. tax authorities have recognized that tax benefits will not be disallowed merely because the foreign tax treatment of the transaction differs from the U.S. tax treatment. [W]here U.S. tax law considers a U.S. person the owner of a leased asset (and the U.S. person contemporaneously and consistently reports the transaction accordingly), and foreign law applied to the same facts nevertheless characterizes a foreign person as the owner of the same asset, U.S. depreciation deductions claimed by the U.S. person generally would not be denied. Similarly, interest deductions of a U.S. person with respect to a hybrid debt security that is treated as equity in the jurisdiction of the security holder generally are allowed unless such deductions are inconsistent with the purposes of other U.S. law (including U.S. treaty obligations) (e.g., because application of a treaty to the hybrid security would inappropriately eliminate worldwide tax rather than serve to alleviate double taxation). Treasury Department, Prescribe Regulatory Directive to Address Tax Avoidance Through the Use of Hybrids, in GENERAL EXPLANATIONS OF THE ADMINISTRATION S REVENUE PROPOSALS at 144 (Feb. 3, 1998). Dual tax ownership will not be a concern in the United States when it is solely the result of differing U.S. and foreign legal standards of tax ownership being applied to the same facts because tax ownership is determined under U.S. legal standards without regard to the tax ownership treatment obtained under foreign law. Tech. Adv. Memo (Aug. 19, 1997); see also Tech. Adv. Memo , (Jan. 9, 1998). 29

31 Cross-Border Leases US Corp Foreign Corp 1.) Sale of Assets Sale Price 2.) Lease of Assets Lease Payments U.S. Corp is treated as the owner of property for U.S. tax purposes; the arrangement is treated as a secured loan Foreign Corp is treated as the owner of property for foreign tax purposes Both parties may be eligible for accelerated depreciation and / or credits in their respective tax jurisdiction; U.S. Corp may also be eligible for interest deductions for U.S. tax purposes 30

32 Hybrid Securities US Corp Foreign Corp $99x Perpetual Debt LLC $1x Common Equity The Perpetual Debt is treated as equity for U.S. tax purposes. Thus, U.S. Corp is treated as the owner of a 99% interest in the LLC s assets. The Perpetual Debt is respected as debt for foreign tax purposes. Thus, Foreign Corp is treated as the owner of 100% of LLC s assets. Similar to the previous transaction, both parties may be eligible to claim depreciation and / or credits in their respective tax jurisdictions. Foreign Corp also may be eligible for interest deductions in its home jurisdiction with respect to the Perpetual Debt. Alternatively, Foreign Corp may lend $99x to U.S. Corp, giving rise to potential interest deductions in the United States. 31

33 Repo Transaction US Corp Foreign Corp 1.) Sale of Property Sales Price 2.) Repurchase of property in future Forward Price For U.S. tax purposes, the arrangement is treated as a secured loan. Thus, U.S. Corp is treated as the owner of the property. For foreign tax purposes, Foreign Corp is treated as the owner of the property. Both parties may be eligible for accelerated depreciation and / or credits with respect to the property in their respective jurisdictions. Additionally, U.S. Corp may be entitled to interest deductions with respect to the deemed secured loan. 32

34 Dual Resident Corporations Foreign Consolidated Group NOTE: The availability of this strategy is constrained by the dual consolidated loss rules. Dual Resident Corp is treated as a member of the foreign and U.S. consolidated groups. Corp is managed in a foreign jurisdiction Corp is incorporated in the United States Dual Resident Corp Subject to the dual consolidated loss rules, double deductions and credits may be available for the foreign and U.S. consolidated groups. US Consolidated Group 33

35 Hybrid Securities 100% Equity Treated as a U.S. resident corporation for U.S. tax purposes Treated as a disregarded entity for foreign tax purposes. Foreign Group Reverse Hybrid Acquisition Loan Subject to certain rules applicable to domestic reverse hybrids and earnings stripping, U.S. tax with respect to the profits generated by the assets may be eliminated as a result of interest and depreciation deductions and credits. No interest income is realized by Foreign Corp in the foreign jurisdiction. Rather, Foreign Corp will be taxed on the profits of the U.S. assets, reduced by depreciation deductions and / or credits. Some U.S. withholding tax may apply to dividends paid to Foreign Corp. 34

36 French Tax Considerations Under French tax law, the U.S. renewable energy property owned by the French Corp may be eligible for 12-month depreciation, provided that the property (i) belongs to one of the categories of renewable energy equipment listed in the French tax code and (ii) does not give rise to a branch in the United States. In general, a branch will not exist provided that the French Corp does not hire employees or dependent agents to operate and maintain the property and does not pay other related expenses. The cross-border lease strategy should be compatible with French tax law. Taxpayers may seek a tax ruling to confirm the French tax treatment of a transaction. 35

37 German Tax Considerations For German tax purposes, the U.S. renewable energy projects may qualify as a permanent establishment in the United States, and, consequently, the profits from the project would not be subject to tax in Germany. Subject to certain factual changes, the cross-border lease, hybrid security and repo transaction strategies should be compatible with German tax law. Taxpayers also should consider renewable energy projects in Germany, which are eligible for significant tax benefits and subsidies, including guaranteed pricing. 36

38 Dutch Tax Considerations Certain Dutch investors may be interested in investing in U.S. renewable energy projects to receive social credit. For Dutch tax law purposes, the U.S. renewable energy project may qualify as a U.S. permanent establishment, resulting in no Dutch tax with respect to the profits of the project. In addition, certain losses generated by the project may be deducted for Dutch tax purposes. 37

39 U.K. Tax Considerations To claim depreciation deductions ( capital allowances ) for U.K. tax purposes, the property must be used in an active trade or business. In the cross-border lease transaction, the taxpayer could argue that the property was part of an active leasing business. The extensive cross-border U.K. anti-abuse rules may disallow many of the tax benefits described in the slides. There may be more scope for tax benefits in a U.K. domestic context. A possible alternative would be to contribute the U.S. property to a U.S. holding company. Provided certain requirements are met, a U.K. company may be able to receive a participation exemption with respect to capital gains on the U.S. holding company shares. 38

40 Presenters Shearman & Sterling LLP Alfred C. Groff Washington, DC T: Mitchell E. Menaker New York T: John M. Sykes III New York T: