North Carolina takes aim at tax equity deals

North Carolina takes aim at tax equity deals

October 09, 2020 | By Keith Martin in Washington, DC

Tax equity investors who invested in North Carolina solar projects expecting to claim a 35% state tax credit are watching two cases closely.

A North Carolina administrative law judge ruled against a mutual insurance company in mid-August that claimed solar tax credits in 2014, 2015 and 2016. The company was hit with a bill for $23.8 million in back taxes, penalties and interest. It invested in a master partnership set up to monetize North Carolina tax credits.

A related case is before a state court.

The cases involve partnerships that Monarch Private Capital organized and syndicated to companies and sophisticated and high-net-worth individuals who invested expecting to be allocated tax credits on solar projects owned by the partnerships.

The state tax department began looking at tax credits claimed by investors in the Monarch partnerships in early 2018. The state ultimately denied the tax credits and, in September 2018, issued a general warning that some partnerships formed to acquire interests in renewable energy projects with the aim of transferring state tax credits to investors are disguised sales of tax credits. Tax credits cannot be transferred through a sale.

North Carolina allowed a 35% tax credit to be claimed on new solar, wind, geothermal, biomass, hydroelectric and combined heat and power equipment through the end of 2016. (Biomass projects had until early May 2017.) Projects that had incurred enough costs or done enough physical work by the deadline were given more time.

The credit had to be claimed ratably over five years on any equipment put to business use. (For more details, see “North Carolina” in the July 2015 NewsWire.)

Monarch received a ruling in 2013 approving one of its transactions.

It filed suit in September 2019 against the North Carolina Department of Revenue after failing to persuade the state to drop the audit adjustments. It said it has raised tax equity for 80 solar projects in North Carolina with a value of $900 million.

Meanwhile, one of the investors — the North Carolina Farm Bureau Insurance Company — was pursuing its own appeal. An administrative law judge decided against the insurance company in mid-August in a case called North Carolina Farm Bureau Insurance Company, Inc. V. North Carolina Department of Revenue.

The administrative law judge said the insurance company had invested in state tax credits rather than the underlying solar projects.

The private placement memorandum describing the insurance company transaction said that a master partnership would be formed that would “generate tax credits” from solar projects owned through lower-tier partnerships.

Monarch was the general partner. Investors were expected, as limited partners, to invest an amount per dollar of projected tax credits. There was no guarantee they would receive them, but the partnership kept some of the invested cash in a reserve to return to investors if there was a shortfall in tax credits.

The offering was of master partnership units “in increments of $100,000 of State Tax Credits.” Investors would not have to invest any more capital.

The offering took place in September 2014. Monarch had an option to buy back the investors’ units during a six-month period starting July 1, 2015 for their fair market value.

Monarch warned investors during the offering that two recent federal court decisions in cases involving Virginia tax credits meant that only part of the investment each investor made in the master partnership would be treated as a capital contribution to the partnership and the rest would be treated as a payment for tax credits.

The federal courts concluded that the investments in the Virginia cases were partly payments for tax credits. They said such payments had to be reported by the partnership promoter for federal income tax purposes as gain from the sale of tax credits rather than as tax-free capital contributions to the partnership. Each investor had to report income equal to the full tax credits less the amount paid for them when the credits were used to offset state income taxes, in the same manner as if the investors had bought property and then converted it to cash and spent the cash. However, the investors could then deduct the state income taxes considered paid in this manner. (For more details, see “A tax credit transaction” in the June 2011 NewsWire and “Tax equity deal struck down” in the February 2016 NewsWire.)

Most states use federal taxable income as a starting point for their own calculations.

The North Carolina Department of Revenue cited the Virginia tax credit cases in 2018 as grounds for denying tax credits to investors in North Carolina partnerships.

In late August, it called attention to the administrative law judge’s decision in a filing in the Monarch court case. The pending court case is Monarch Tax Credits, LLC v. North Carolina Department of Revenue.