An Unusually Large Number
An unusually large number of issues of interest to the project finance community are on the latest business plan the IRS released at the end of July.
The business plan is a list of issues the IRS hopes to address by June next year.
The IRS hopes to settle in what circumstances solar rooftop equipment can be owned by real estate investment trusts or REITs. The issue is whether such equipment qualifies as “real property.” The IRS issued a proposed new definition of real property for REIT purposes in May 2014. Under it, a REIT that owns a building can also own solar equipment that is used to supply electricity to the building occupants. (For earlier coverage, see the June 2014 Project Finance NewsWire article REITs.) However, it is not clear a REIT could own rooftop solar systems in other situations. Five US Senators wrote the IRS and Treasury on August 17 asking it to drop a requirement that solar panels would qualify as real property only if the REIT owns an “equivalent interest” in the solar equipment to its interest in the building.
The IRS hopes to issue guidance on the tax treatment of prepaid forward contracts. It has had such guidance in the works since 2008. The focus was originally on the tax treatment of forward contracts in the foreign exchange market, but the guidance has the potential to affect the tax treatment of prepaid power contracts.
The agency is also working on guidance about advance payments for goods and services. US tax rules let a company that is paid in advance for goods – for example, electricity or gas – spread the taxable income out in certain circumstances over the period the goods are delivered. This is a key feature of prepaid power contracts. Any new guidance is expected to focus mainly on amounts received for gift cards, trading stamps and loyalty points that can be redeemed for goods and services.
Another issue the agency expects to address is whether interest must be accrued on distressed debt. The issue is at what point accrual should no longer be required because of little likelihood the interest will be paid.
A notice is expected this fall on inverted leases in the solar market. The lessee in such a lease claims an investment credit, and has to report income equivalent to half the credit ratably over five years. Some lessees that are partnerships between the solar company and tax equity investor are then bumping up the “outside basis” of the tax equity investor by this income. The tax equity investor eventually withdraws from the lessee partnership and deducts the outside basis as a tax loss. The IRS believes this is inappropriate.
Another issue receiving attention is the problem of congestion on the utility grid. Independent generators must connect their power plants to the grid to get the electricity to market. The local utility to whom the plant interconnects requires the generator to reimburse it for the cost of substation improvements and upgrades to the grid to accommodate the additional electricity. The cost reimbursement does not have to be reported by the utility as income as long as, among other things, the generator is careful to transfer title to the electricity from its power plant to someone else before the electricity reaches the grid. The generator must not be considered a customer of the grid for wheeling. If a utility must pay taxes on the amount, then it will charge the generator more for interconnection.
Some cost reimbursements are made today to neighboring utilities to relieve congestion in other parts of the regional grid that, if not addressed, could lead to curtailment of the independent generator’s facility. The IRS is updating its guidance in this area to clarify that cost reimbursements to neighboring utilities do not have to be reported as income either. The IRS has suspended any private rulings on the subject in the meantime.
The IRS expects to issue final guidance on the tax treatment of series LLCs. Proposed regulations were published in 2010. At least nine US states, the District of Columbia and Puerto Rico have statutes that allow limited liability companies to create different pockets or cells of investments, each potentially with different owners, a different managing member and different assets. In at least three of the nine states, each series can have a separate right, in its own name, to sign contracts, hold title to assets and grant liens and security interests in the assets belonging to that series. The IRS suggested in 2010 that each cell or subsidiary of the series LLC can have a different tax classification. (For earlier coverage, see the November 2010 Project Finance NewsWire article Series LLCs.)
Some partnership agreements use “targeted allocations.” IRS regulations require partnerships to keep a capital account for each partner that tracks what the partner contributed and what he got out of the partnership. When the partnership liquidates, the capital accounts are supposed to be used by partners to divide up what remains. However, with targeted allocations, the partnership simply divides up what remains according to a business deal. It tries during the life of the partnership to share economic returns in a manner that causes the capital accounts to remain in the ratio the business deal requires any assets remaining at liquidation to be shared, but there is no guarantee the capital accounts will be in this ratio. (For earlier coverage, see the April 2014 Project Finance NewsWire article Targeted Partnership Allocations.) The AICPA, the trade group for the accounting profession, urged the IRS in 2014 to address targeted allocations because of what it said is a widespread misperception that the IRS approves of such allocations. The issue is on the latest business plan.
The agency will finalize proposed guidance it issued in May 2015 about the types of activities in which master limited partnerships or MLPs may engage in an energy business. Such MLPs must have at least 90% good income each year to maintain status as a partnership for tax purposes; otherwise, they are taxed like corporations. (For earlier coverage, see the July 2015 Project Finance NewsWire article Line Drawing for MLPs.) Boardwalk Pipeline Partners LP and Westlake Chemical Partners sent letters to the IRS in July urging it to allow MLPs to produce olefins from natural gas. Both companies were issued private letter rulings by the agency in 2013 that said MLPs established by the companies could process natural gas liquids into olefins. The IRS reversed course in the proposed new guidance in May. As many as 12 companies that were issued private letter rulings granting them MLP status will not qualify under the new rules.
Another issue the IRS plans to address is whether a company that holds out equipment for sale or for lease can depreciate it while doing so. A leasing company can depreciate equipment that it uses in its leasing business. Inventory that a vendor holds out for sale cannot be depreciated because the equipment is not considered in service.
Another issue is how the installment sale rules work when part of the purchase price is contingent. Under an installment sale, the seller reports his profit as taxable income over time as a fixed percentage of each payment of purchase price from the buyer. The seller must pay the IRS interest on the deferred tax liability.
The IRS also expects to issue guidance on the “treatment of deferred revenue in taxable asset sales and acquisitions.”
Finally, municipalities that issue tax-exempt bonds to finance schools, roads, hospitals and other public facilities must be careful not to allow more than 10% “private business use” of the facilities or the bondholders could end up having to pay taxes on the interest they receive on the bonds. Hiring a private company to operate and maintain a facility can be private business use, depending on the terms of the management contract. The IRS rules in this area date to a 1997 revenue procedure, Revenue Procedure 97-13. The IRS plans to update them.
The Edison Electric Institute, the trade association for the regulated electric utilities, asked the IRS to address whether homeowners who receive net metering credits for sending surplus solar electricity to the grid from rooftop solar panels should report the credits as taxable income. (For earlier coverage, see the July 2015 Project Finance NewsWire article Several Tax Policy Issues.) The IRS chose not to include the item on the business plan.