Treasury Cash Grant Update
The US Treasury Department is still wrestling with what it means to start construction of a new wind farm, solar project or other renewable energy facility.The answer is now not expected until March.
The issue is important because projects must be under construction by the end of 2010 to qualify for cash grants from the US Treasury for 30% of the project cost. The Treasury is expected to say either that a company must have made nonrefundable payments of more than 5% of the eventual project cost or that it must have accrued such spending. Spending “accrues” when the company is on the hook legally to pay the amount even if the amount has not been paid yet.
Meanwhile, the House tax-writing committee is moving to extend the cash grant program.
The economic stimulus bill last year directed the US Treasury to pay owners of new wind, solar, geothermal, biomass, waste-to-energy, landfill gas, fuel cell and ocean energy projects 30% of the project cost — or, in some cases, 30% of the market value — in cash. Small cogeneration units of up to 50 megawatts in size also qualify for payments, but at a 10% level.
The payments are made within 60 days after a project is placed in service or, if later, after a complete application is submitted.To qualify for a cash grant under the existing program, a project must either start construction or be completed in 2009 or 2010.
The program was intended as a temporary stimulus to keep projects on track in 2009 and 2010 when the economy was expected to remain weak. Projects that merely start construction in 2009 or 2010 must be completed by a deadline.The deadline is 2012 for wind farms, 2016 for solar, fuel cell and small cogeneration facilities and 2013 for other projects. A bill expected to be introduced shortly in the House would create a new program that would replace the existing cash grant program when it expires. Under the new program, the government would treat the owner of a new project as if it overpaid income taxes for the year the project is completed.The owner would be entitled to a refund of the money.The new program would apply to projects that start construction in 2011 or 2012.The deadlines to complete the projects would remain the same as under the existing program.
The House Ways and Means Committee staff began telling lobbyists last fall that it favors extending the cash grants because they are a more efficient way to direct money to renewable energy; more of the dollars end up being spent on projects than with tax credits that developers must barter in the tax equity market to convert into current cash. The outlook for an extension in the Senate is unclear. President Obama did not ask Congress to extend the cash grant program in the fiscal 2011 budget he presented to Congress on February 1. He did ask it to extend a similar cash grant program under which the Treasury pays the cash value of tax credits for low-income housing projects.The authority for the low-income housing program expired at the end of 2009, while the renewable energy program has another year to run. Many lobbyists believe any extension of the cash grants for renewable energy will not occur before late in the year at the earliest. Nonetheless, they are eyeing a “jobs” bill that is expected to take shape in Congress as early as February as a possible vehicle for an extension.
Cash grants are being paid by the US Treasury in as little as two to three weeks after complete applications are received. This article describes a number of other developments.
Start of Construction
Projects must be under construction by December 2010 to qualify for grants under the existing program. There are two ways for a developer to show that a project is under construction.
One is to show that “physical work of a significant nature” started.
The Treasury gave two examples in guidance last July 9. A project is considered under construction when “work begins on the excavation for the foundation, the setting of anchor bolts into the ground, or the pouring of the concrete pads of the foundation.” It is also under construction “if a facility such as a wind turbine and tower unit is assembled on-site from modular units manufactured off-site” and assembly “of a significant nature” has started at the factory.
However, few wind and solar developers plan to rely on the physical work test; it is considered too vague. For example, the Treasury considers each turbine, pad and tower at a wind farm as a separate property.The developer can elect to treat all turbines on a single site as one project. Is it enough for a wind developer to have poured concrete for three of 67 turbine pads by December 2010? What percentage of the foundations for a multi-turbine project like a wind farm must have been excavated or laid? If the company wants to rely on physical assembly of turbines having started at the factory, how many must have been assembled?
Therefore, most attention has focused on the second test. Construction starts when the developer has “incurred” more than 5% of the total cost of the project. Spending for “preliminary activities,” such as engineering and design work, securing power contracts and permits and negotiating financing, does not count.
The Treasury said on July 9 that it is not enough merely to have spent the money on turbines and similar equipment that will be incorporated into the project; there must also be “economic performance,” meaning that the developer must actually have taken delivery of (or legal title must have passed to) equipment that represents more than 5% of the total project cost.
Treasury officials have been saying privately since the fall that the economic performance requirement goes farther than Treasury intended.
The agency is considering treating companies as having started construction under the 5% test if they have merely “accrued” more than 5% of the project cost. An amount accrues when a company is legally obligated to pay it.
However,Treasury officials worry about trafficking after 2010 in grandfathered contracts.The fear is that a small industry will grow up in 2010 of brokers who use shell companies to sign equipment contracts that require payments of X% and then sell the contracts after 2010 to developers whose projects were not far enough along in 2010 to commit to their own contracts. One way to deal with this problem is to require developers actually to have paid the amounts they want to count toward the 5% test.
Projects often come in over budget.The Treasury is not keen to let developers apply the test based on expected costs in 2010. It advises paying well above 5% to leave a margin for error in case the final cost is higher than expected.
Larger wind and solar developers sometimes enter into frame or master agreements where they place a large turbine or module order and decide later where to use the equipment. It is not clear whether equipment ordered under a frame agreement can count toward the 5% test until it has been designated for use in a particular project.There was discussion at a Treasury meeting in October about letting such costs count as long as the turbines are designated for use in a particular project on a cash grant application filed with the Treasury by September 2011 — the deadline for all remaining grant applications to be submitted under the existing program.
These issues are expected to be addressed in a long list of questions and answers on which the Internal Revenue Service has been working since the fall.The current release date is sometime in March.
Congressman Earl Blumenauer (D.-Oregon) is expected to introduce a bill in February that would extend the deadline to start construction of new projects to qualify for cash grants by another two years through 2012. It would also convert the program into a tax refund program rather than a cash grant program.
The difference is important.
Under the bill, the government would pretend that the owner of a project overpaid his taxes and could apply for a refund. Cash grants under the current program are paid within 60 days after a project is completed or, if later, a complete application is submitted.The tax refunds under the new program would be paid a lot later — after the annual tax return is filed for the year in which the project is completed.
The current cash grants are certain; the Treasury has no discretion.The refunds would be subject to offset if the taxpayer owes other taxes or has debts to other federal agencies and, in some cases, also owes unpaid state taxes.
Projects that are owned by partnerships do not qualify for any cash grant under current law if a government or taxexempt entity owns an interest, no matter how small or indirect.Thus, projects owned by private equity funds have a hard time qualifying for grants.They can qualify if the private equity fund invests through a blocker corporation.The bill would get rid of this “cliff” and substitute a “proportionate disallowance” rule instead. For example, if state pension funds own 12% of a project, then any refund would be reduced by 12%. The bill would help geothermal and other developers whose projects do not qualify for grants currently because construction may have started before 2009.When construction started would no longer matter as long as it starts by 2012 and is completed by a deadline.
The deadlines would remain the same as under the existing program, except that geothermal projects would be given until 2016 — instead of 2013 — to be completed. Developers would have the option to move to the new program immediately after it is enacted rather than have to wait until after the current cash grant program expires.
The bill would make it easier for regulated utilities to own renewables projects in states that have renewable portfolio standards requiring utilities to supply a certain percentage of electricity from renewable energy. Utilities in such states could qualify for refunds on projects they own without having to show that they use a “normalization” method of accounting. If the federal government were to adopt a national renewable energy standard, utilities in all states would have an easier time.
The reason the House wants to move to a refund program in place of cash grants has to do with committee jurisdiction in the House.The tax-writing committee shares jurisdiction over the cash grant program with two other “spending”committees.The tax-writing committee wants to extend the program of cash payments in as close a form as possible to the existing program. It is trying to find a way to do so without having to enter into a potentially tangled process with the spending committees. Senate tax staff said last fall it was premature to talk about an extension before any results were in.
Any extension will have to be attached to another, larger measure; it will not pass alone.
Lobbyists for independent power companies are cautiously optimistic that the California legislature will vote by March to waive state taxes on the Treasury cash grants.
Leaders in both the state senate and state assembly appear to be on board.The move also has the support of the governor. The state estimates that waiving taxes will cost the state $70 million in revenue that it would otherwise have collected. If legislative leaders can find the money elsewhere, then the need for a two-thirds vote can be avoided.The state is facing a $20 billion hole in its budget this year.
The grants are not taxed at the federal level. However, grants paid on California projects are subject to tax in California, according to the Franchise Tax Board.The state franchise tax is 8.84%. Any state franchise taxes paid are deductible at the federal level.
The problem is California uses federal tax law as a starting point for calculating state taxable income, but it only “conforms” to the federal tax code as it existed on January 1, 2005.The cash grant program and the directive in the federal tax code that the grants not be taxed were enacted in February 2009.
The state legislature voted last summer to move the conformity date forward to January 1, 2009. Governor Schwarzenegger vetoed the bill on October 11.The veto message complained about an extraneous provision that was inserted in the bill at the last moment.
The state tax committee chairmen have said they have no appetite for trying to pass another general conformity bill this year.The lobbying efforts are focused instead on a narrow bill that deals just with the Treasury cash grants.
Companies who have not already been paid grants on California projects would be wise to wait to apply until after the legislature has acted in case any bill passed is only prospective in effect. Recent bill drafts have the measure taking effect retroactively, but there is no guarantee that is the form in which the bill will pass.
The Treasury has decided to make it easier for geothermal companies to qualify for cash grants on power projects on which drilling started before 2009.
Geothermal companies have a harder time qualifying for grants than many other developers because drilling at the field to prove the resource is sufficient to support the proposed power plant may have started in 2007 or 2008 for a power plant that will not be completed until 2011 or 2012. A developer qualifies for a grant only if his project is completed in 2009 or 2010 or starts construction in 2009 or 2010.
Exploratory drilling does not count as the start of construction. However, the line between an exploratory well and a production well is not always clear.
The Treasury has decided that it will count as an exploratory well drilling to prove the resource is adequate to support the power plant the developer wants to build, even when one or two wells are drilled to production depth and diameter and are converted later into production wells.
The Treasury is expected to post a question and answer to that effect on its website.
A project that is owned by a partnership for tax purposes does not qualify for a cash grant if a government or tax-exempt entity, electric cooperative or Indian tribe has an interest in the project, no matter how small or how remote. Most private equity funds have at least some such entities as investors. Therefore, projects or developers owned partly by private equity funds have trouble claiming cash grants.
The Treasury pointed to a way around the ban in January. It said in a question and answer posted on its website that a developer who does not qualify for a cash grant can still benefit indirectly by selling his project to a tax equity investor who can use the grant and leasing it back.The tax equity investor will qualify for the full grant.
The Treasury had been saying this since September.This was the first time it put its position in writing.
There would still be a partial loss of depreciation.The portion of the project that is considered owned by government and tax-exempt entities will be labeled “tax-exempt use property”and must be depreciated more slowly.
Projects must be sold and leased back within three months after they are first placed in service.
The ability to avoid the cash grant ban by selling and leasing back a project has several consequences.
Rooftop solar companies will be able to lease rooftop systems to public schools, universities, government agencies and other tax-exempt entities without losing the cash grant. However, it is still better to enter into power contracts to supply electricity to such entities — rather than lease them the equipment — to avoid a loss in time value of depreciation. A solar system leased to a government or tax-exempt entity is depreciated over 12 years on a straight-line basis rather than five years using the 200% declining balance method.
Developers planning joint ventures with Indian tribes, municipal utilities or electric cooperatives to own projects would be able to benefit indirectly from a full cash grant on the project by having the joint venture sell and lease back the project.
A municipal utility or cooperative could develop and project and do the same.
Some developers have been pressing Congress to amend the stimulus bill to relax the cash grant ban.The House Ways and Means Committee staff offered in late December to rewrite the current ban so that partial ownership by government or tax-exempt entities would not lead to total loss of the cash grant, but rather to loss of the same fraction of the grant as the government or tax-exempt ownership.This fix is expected to be folded into any bill in the House to extend the cash grant program.
Leasing is most attractive to tax equity investors if they can use leveraged lease accounting.This sometimes requires leaving the cash grant with the developer, as lessee, so that the debt at the lessor level is at least 50% of the price the lessor paid for the project.The Treasury action does not help in these situations, since the developer would not be able to claim a cash grant directly.
There are questions about how deep a lease market there is for wind farms because of the potential variability of revenues to pay rents. At least two wind developers have had projects in the market trying to raise lease equity. One had reportedly been withdrawn by the time the NewsWire went to print.