Tax basis issues: Alta Wind
Tax basis issues remain largely unresolved after a US appeals court decision in late July in a closely-watched case involving Alta Wind.
The case is headed back to the US Court of Federal Claims to be reheard and will be assigned to a new judge.
It has the potential to affirm or upset current practice in the tax equity market of assigning most of the value paid for renewable energy projects to the generating equipment as opposed to intangibles like a power contract or going concern value. Going concern value is the extra value for which a buyer might pay for an existing business due to the seller having already pulled all of the pieces together.
The typical appraisal in the renewable energy market allocates 95% to 98% of the price paid for a wind or solar project to the generating equipment. Investment tax credits and depreciation are calculated on the generating equipment and not on land, transmission assets or power contracts, interconnection agreements or other intangibles.
The case, called Alta Wind v. United States, involves six wind farms in California. Five of the wind farms were financed in sale-leasebacks. One was sold to EverPower. All of the projects had long-term power contracts to sell their electricity to Southern California Edison.
The owners of the projects — mostly tax equity investors — applied for Treasury cash grants based on what they paid for the projects rather than what the developer, Terra-Gen, spent to build them. The sale-leasebacks occurred in 2010 and 2011. One project was sold to EverPower in 2012.
At the time, the US Treasury was paying owners of new renewable energy projects 30% of their tax bases in the generating equipment under a so-called section 1603 program that was part of a group of economic stimulus measures that Congress passed in early 2009 to help pull the economy out of a tailspin. Anyone receiving a Treasury cash grant had to forego tax credits, but could still depreciate the project.
The Alta investors assigned 93.1% to 96.9% of what they paid for the projects to the generating equipment and the rest to other assets. Edward Settle, the public face of the Treasury cash grant review team at the National Renewable Energy Laboratory, testified at trial that NREL had a rule of thumb that 95% of the cost of the average wind farm is basis in eligible equipment.
The Alta owners had unusually strong evidence to support the overall prices they paid for the projects. Terra-Gen, the developer, had put the projects out for sale in an auction. The prices paid by the tax equity investors were at most 2% above the bids received in the auction.
The government did not challenge the overall prices, but said that roughly 29% of what was paid should have been treated as purchase price for intangibles.
Its view was that the tax equity investors should have added up the value of the equipment first and then treated any remaining purchase price as basis in intangibles like customer goodwill or going concern value.
This is the approach that section 1060 of the US tax code requires when buying a business as opposed to a piece of equipment. IRS regulations require separating the assets that come with the business into seven asset classes from easiest to hardest to value. Classes I through IV are, in order, cash, things like commodities that are actively traded so that quotes are readily available, accounts receivable and inventory held out for sale. All other tangible assets go into class V. Class VI is intangible assets like power contracts, site leases and licenses. Any remaining purchase price goes into class VII and is considered a payment for customer goodwill or going concern value.
The claims court said this approach only applies to the sale of the kind of business that has customer goodwill. There is no customer goodwill in a power plant that is not yet operating and that has only a single utility as a customer under a long-term power purchase agreement, the court said.
It said the projects were worth more than they cost to build, but it called the appreciation “turn-key value” that goes into basis in the power plant, reflecting the fact that a power plant is worth more at the end of construction than the bare cost to build it.
The appeals court suggested that the section 1060 method of allocating purchase price should be used in all sales of projects. IRS regulations suggest it should be used when the sales price exceeds the cost to construct or any intangibles are included with the project.
The claims court had suggested that a power contract that requires electricity to be supplied from a particular power plant has no value independently of the power plant. The appeals court did not address this, but rather focused on whether part of the purchase price paid for a project not yet in operation and with a long-term power contract could be for customer goodwill. “[W]e think goodwill can arise based on contracts,” the court said.
In the final analysis, the appeals court said, “the government agrees that turn-key value accounts for some portion of the purchase price.” But it suggested there was also value “from having secured a customer contract, regulatory approvals, transmission rights, and various other arrangements that ensured the immediate operation of the Alta windfarms.” It sent the case back to the claims court to revisit how much of the purchase price to treat as turn-key value. It also suggested the claims court consider whether the right to a Treasury cash grant and Terra-Gen indemnity if the grant fell short were also intangibles that should be backed out of the grant basis.
At the end of the day, the appeals court did not like the process the claims court used, but did not give it much guidance for how to redo the numbers. Appraisers who are not already doing so will have to consider whether to use a section 1060 approach to allocating purchase price.
The court missed an opportunity to settle whether power contacts that are bolted to a particular power plant, and cannot be transferred without the power plant, have independent value.
Some developers had switched this year in tax equity deals from paying developer fees to selling the project company to the tax equity partnership near the end of construction as a better way to support a fair market value basis in the power plant. After the latest Alta decision, that strategy seems no better than developer fees.
A separate test case of whether developer fees paid under a development services agreement by a project company to the developer go into basis was the subject of a four-day trial in late July in the claims court. A decision is expected later this year.
The project company in that case paid the developer a developer fee of $50 million, or 12.3% of project cost, on a wind farm in Illinois and put the amount in basis for a Treasury cash grant. The Treasury said the developer fee should not count toward the cash grant because it was circled cash: the developer made a capital contribution to the project company to pay itself a fee. The government also argues that the fee is not a real “fee” because it was a function of what the developer could have earned on a sale of the project rather than the actual services performed.
The developer fee case is California Ridge Energy, LLC v. US. A companion case that was heard at the same time involving a second wind farm with the same issues is called Bishop Hill Energy LLC v. US. (For earlier coverage, see “Treasury Cash Grant Update” in the February 2016 NewsWire and “PPAs and Developer Fees” in the February 2018 NewsWire.)