Treasury Cash Grants
Treasury cash grants on renewable energy projects remain a hotbed of activity.
A significant number of solar companies are in discussions with the Treasury about the grants they were paid on their projects. The grants are subject not only to a 7.2% haircut due to sequestration, but also the Treasury has been taking a hard line on the basis it will accept for calculating grants.
Most disputes are over developer fees included in basis, allocation issues such as how much of the purchase price the developer paid to buy the project rights before construction or a lessor paid in a sale-leaseback should be allocated to intangibles like the power contract, and prepaid rent in sale-leasebacks.
The Treasury’s current view is that developer fees should generally not be more than 2% to 5% of project cost. There are exceptions where a developer can show it had a lot of capital at risk for a long period of time.
The Treasury believes that power contracts have value to the extent they are in the money. Some accounting firms are taking the position that a contract has no value if the contract prices for electricity were market at the time the contract was signed.
Treasury rejects this, and believes that the time to value the contract is when the contract was sold to the developer before construction. Tax equity transactions present more complicated issues. If the contract was sold as part of a tax equity deal at the end of construction, some accountants and counsel argue the comparison should be to electricity prices when the owner would have had to have such a contract in place to have the project in commercial operation on the date the tax equity deal closes.
The Treasury is troubled by prepaid rent in sale-leasebacks. It believes that the peculiar math in the solar market means it is in the interest of both the tax equity investor and sponsor to have the lessor pay more for the project and then have the sponsor repay the lessor immediately with prepaid rent. Thus, when the Treasury sees prepaid rent, this raises questions whether the tax basis claimed by the lessor for calculating the Treasury grant is inflated.
The Treasury has been doing a calculation to adjust prepaid rent to what it views as a supportable level and then back into the amount the lessor should have paid. It treats the prepaid rent as the lessee investment and then determines what internal rate of return the lessee is earning on that investment. The internal rate of return is the discount rate that would set the present value of the net revenue the lessee expects from use of the project during the lease term equal to the prepaid rent. If the discount rate is less than what Treasury views as a reasonable return for the lessee, then it reduces the prepaid rent.
The lessee’s gain on the sale part of the sale-leaseback is not taken into account as part of the lessee benefits stream. Many lessees do the calculation, but assume they will buy the project at the end of the lease term or extend the lease. The Treasury does not permit such assumptions.
If the prepaid rent is too high, then the Treasury asks the lessor how much less it would have paid for each dollar reduction in prepaid rent. This backs into the lessor purchase price the Treasury will accept.
There is still the question how much must be allocated to intangibles like the power contract. Even if the power contract is retained by the lessee in the sale-leaseback and is not part of the assets that were sold to the lessor, the income method that appraisers use to value projects takes the power contract into account indirectly.
The Treasury began also using a new “upward bound” calculation in November to set a cap on how high a basis it is willing to accept in sale-leaseback transactions. The calculation is the purchase price paid by the lessor plus the present value of the after-tax net benefits stream the lessee expects over the lease term (taking into account not only the net revenue expected from electricity sales, but also the prepaid rent, reserves and lease-related transaction costs), minus the tax rate times the purchase price paid by the lessor. The entire amount is then divided by one minus the tax rate.
Two more lawsuits were filed in November by grant applicants who received less than the grants for which they applied, bringing the total number of pending cases to 12. All the suits are in the Court of Federal Claims. The oldest has been pending since July 2012. One suit was withdrawn after the government filed a counterclaim accusing the solar company that brought it of fraud.
Both new suits involve projects that were sold and leased back the same day they went into service. Treasury cut the grants by 31% in one case and 28.5% in the other. The sale-leasebacks were only of the eligible equipment at each project that qualified for a grant. Both cases raise issues about whether the Treasury can allocate part of the purchase price paid by each lessor to intangibles (that do not qualify for grants), given that the parties sold and leased back only the eligible assets while leaving the intangibles with the lessee, and whether the Treasury can omit a “turnkey fee” and a separate “developer’s premium” in calculating the eligible basis in its cost-up approach. The Treasury validated the bases it was willing to accept in part by adding up the eligible costs of the lessees to build the projects rather than focus solely on the purchase price paid by each lessor.
A solar developer that filed a Freedom of Information Act request for documents relating to grants paid to another solar company was told in late October that the estimated processing fee to copy the documents would be close to $50,000. The Treasury said the cost could be cut to $6,400 if it did not have to produce lots of duplicate paperwork that appeared to be the same from one grant application to the next. Because the processing fee was more than $250, it had to be paid in advance.