Prepaid power contracts or leases may create complications when assets are sold.

Some wind and solar companies that sell electricity under long-term contracts are paid in advance by the offtakers or customers.

They do not report the advance payments immediately as income but rather report income over time as the electricity is delivered. If the assets used to supply the prepaid electricity are later sold — for example, in a tax equity transaction — it is unclear what tax basis the buyer should take in the assets, according to a paper the tax section of the New York State Bar Association sent the IRS and Treasury in January.

The bar association said there are two possible answers.

One, which it called an “assumption approach,” is to treat the buyer as having assumed a contingent liability. For example, suppose a buyer pays $1.2 million for a solar project for whose electricity a customer has paid in advance, and the buyer is expected to have to spend $800,000 to deliver the electricity, but the actual amount the buyer will have to spend cannot be known with any certainty.

The buyer values the asset by subtracting this contingent liability. Therefore, were it not for the obligation to deliver the electricity without any further payments from the customer, he might pay $2 million for the project. Instead, he pays the net amount of $1.2 million and takes that as his basis in the project for depreciation. As he spends money in the future to deliver the prepaid electricity, he adds the amounts he spends to his basis in the assets. If he bought a project for $1.2 million in cash and assumed debt of $800,000 he would have a basis of $2 million.
However, contingent liabilities do not go into basis until they are paid.
The bar association calls the other possible approach a “fragmentation approach.” The buyer would be treated as having paid the seller $2 million, but then having received $800,000 from the seller to assume the contingent liability. The buyer would have a basis of $2 million for depreciation. He would have immediate income of $800,000.

The bar association urged the IRS and Treasury to issue guidance. It called the issue one of “longstanding uncertainty.”

Its paper is called “Report on Treatment of ‘Deferred Revenue’ by the Buyer in Taxable Asset Acquisitions” and is dated January 7, 2013.

by Keith Martin