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PRODUCTION TAX CREDIT BASICS

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PRODUCTION TAX CREDIT BASICS James F. Duffy, Esquire Nixon Peabody LLP 100 Summer Street Boston, MA 02110-2131 (617) 345-1129 (866) 947-1697 (fax) jduffy_at_nixonpeabody.com – PowerPoint PPT presentation

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Title: PRODUCTION TAX CREDIT BASICS


1
PRODUCTION TAX CREDIT BASICS
  • James F. Duffy, Esquire
  • Nixon Peabody LLP
  • 100 Summer Street
  • Boston, MA 02110-2131
  • (617) 345-1129
  • (866) 947-1697 (fax)
  • jduffy_at_nixonpeabody.com

IPED Financing Wind Power The future of
Energy May 7-9, 2008 Scottsdale, Arizona
2
The Production Tax Credit
  • The production tax credit (the PTC) under
    Section 45 of the Internal Revenue Code remains
    the principal federal incentive for wind
    production
  • The following is a brief summary of the PTC,
    together with interpretations thereof, and
    Revenue Procedure 2007-65 (November 5, 2007) in
    particular

3
Using the Production Tax Credit
  • Dollar-for-Dollar reduction in Federal income tax
    liability
  • Under current law, the wind facility must have
    been placed in service prior to January 1, 2009
    in order to be eligible for PTCs

4
  • The PTC is currently (for 2007) 2.0 cents per
    kilowatt hour of electricity produced by the
    taxpayer and sold to an unrelated person, for a
    10-year period beginning on the date the facility
    was originally placed in service
  • So, the amount of tax credits depends upon the
    amount of electricity generated

5
  • The Produced by the Taxpayer requirement means
    that the owner of the wind project receives the
    PTCs
  • So, you cant just sell PTCs you have to make
    the purchaser of the PTCs an owner of the wind
    project

6
  • Most developers of community wind projects
    either (i) do not anticipate having Federal
    income tax liability for the next 10 years such
    that they will be able to take advantage of the
    PTCs themselves, or (ii) need to monetize the
    PTCs up front in order to help pay for the costs
    of developing their project

7
  • One option is that at or just before the date
    when a wind project is placed in service, the
    developer will sell the entire wind project to a
    purchaser who will then own the project and
    receive the PTCs
  • Under this scenario, the value of the PTCs is one
    component of the total purchase price paid for
    the project

8
  • Also, under this typical structure, the original
    developer generally gives up control of the
    project
  • Particularly in a community project, the original
    developer may not want to give up control of the
    project, as the original developer is generally a
    part of the local community

9
Syndicating the Production Tax Credits
  • Section 45(e)(3) of the Internal Revenue Code
    anticipates that the owner of a project may have
    more than one owner
  • Section 45(e)(3) provides that if a project has
    more than one owner, the PTCs will generally be
    shared by the owners in proportion to their
    respective ownership interests in the gross
    sales from the facility

10
  • The way to structure a transaction so that there
    is more than one owner for tax purposes is
    generally to use a limited partnership or a
    limited liability company
  • For tax purposes, a partnership (which includes a
    limited liability company) is not recognized as
    an entity, so that the partners are treated as
    owners as to their allocable interests in the
    partnership

11
  • The original developer can structure the legal
    owner of the project as a limited partnership or
    an LLC, and the investor who is interested in the
    PTCs can be a limited partner or member thereof
    and thus an owner for tax purposes
  • The owner can then allocate almost all (up to
    99) of the PTCs to the investor

12
  • The original developer can remain in control of
    the wind project by being the general partner of
    the partnership (or the managing member of an
    LLC)
  • But, remember that the PTCs are shared between
    the owners in proportion to their shares of
    gross sales
  • So, in my example the investor would have to have
    a 99 interest in the gross sales of the facility

13
  • However, the developer could also receive a
    reasonable development fee for developing the
    project, and to the extent that there were
    insufficient sources of funds to pay that fee up
    front, some of it could be deferred and paid out
    of operating revenues
  • In addition, the original developer, in its
    capacity as the general partner of the limited
    partnership, can receive a reasonable annual fee
    for managing the project

14
  • Debt on the project could be paid prior to
    reaching the 99-to-1 sharing ratio
  • Where the developer has contributed capital to
    the limited partnership to fund the gap between
    the total development costs and the amount of the
    investors capital contribution, under Rev. Proc.
    2007-65 the developers capital contribution can
    be returned as a priority cash flow item prior to
    the 99-to-1 sharing ratio

15
  • The developer could borrow outside the
    partnership to obtain this capital, generally
    pledging to the lender as collateral the
    developers interest in the partnership
  • The investors payments can be characterized
    entirely as capital contributions to the owner
    limited partnership or they can be characterized
    partially or entirely as a purchase price for the
    investors interest in the owner limited
    partnership

16
  • A simple syndication structure for a wind project
    is as set forth on the following slide

17
99 Limited Partner (Investor)
1 General Partner (Developer)
Limited Partnership (Owner)
Wind Project
18
  • Also, at some point after the end of the 10-year
    PTC period, there could be a flip to give the
    general partner (the developer) a greater
    percentage interest (up to 95) in the projects
    cash flow
  • And at some point after the 10-year PTC period
    (or after the investor has achieved a targeted
    IRR yield), the general partner/developer could
    have an option to buy out the limited
    partner/investors interest at its fair market
    value

19
  • The investors payment can be made up-front, so
    that it can be used as owners equity in the
    development process, or to pay off development
    period financing
  • The investor could pay most (up to 80) of its
    funds on a pay-in schedule of up to 10 years, as
    PTCs are delivered (a pay-as-you-go plan), but
    at least 75 of the investors reasonably
    expected investment must be fixed and
    determinable and not contingent

20
  • These are just general concepts. The terms of
    the syndication of the Production Tax Credits
    from each wind project will vary, based in part
    upon the economics of the particular transaction.

21
  • Because of the sophisticated tax structuring
    involved, there will be not insignificant legal
    and accounting costs in each of these
    transactions, so it may not be as cost-efficient
    to syndicate the PTCs in this manner for smaller
    community wind projects, unless either (i) the
    investor is a community-oriented company willing
    to make a relatively small investment or (ii) a
    community wind project can be pooled with other
    similar community wind projects to provide a
    larger investment to cover the transaction costs

22
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23
  • In the model shown on the chart on the previous
    slide, each community wind project can be
    structured based upon its own economics and can
    negotiate its own business deal with the
    investment fund

24
  • The investor does benefit from diversification of
    sponsor and wind regime, and perhaps off-taker,
    compared to an investment in one large project
  • To keep down transaction costs, the same base
    documentation can be used as the starting point
    for each project

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25
  • Facilitating these structures is an area where
    the states and public advocacy groups could be
    very helpful
  • States and institutional non-profits have done
    this in the housing tax credit area

26
PTC POINTERS
  • The PTC is reduced by up to 50 to the extent
    that project costs are funded by (i) federal,
    state or local government grants for use in
    connection with the project, (ii) the proceeds of
    state or local tax-exempt obligations, (iii)
    subsidized energy financing provided directly or
    indirectly by federal, state or local programs or
    (iv) other credits allowable with respect to any
    property which is part of the project

27
  • For the first 4 years of the 10-year PTC tax
    credit period, PTCs can be applied to reduce the
    investors Alternative Minimum Tax
  • Facilities are generally depreciated over 5 years
    (5-year MACRS)

28
  • PTCs are received by the taxpayer as they are
    earned, so there is no recapture risk to an
    investor if the investor sells its PTC investment
    during the 10-year PTC period (this is an
    advantage over many other tax credits where there
    is a tax credit recapture risk if the investment
    is disposed of during the tax credit period)

29
  • The amount of the PTC, currently 2.0 cents per
    kilowatt hour of electricity generated, is
    re-calculated by the IRS for each year of the PTC
    period of a facility (it was 1.9 cents per
    kilowatt hour for 2006)

30
Revenue Procedure 2007-65
  • Revenue Procedure 2007-65 (effective November 5,
    2007) gives guidance in structuring wind energy
    transactions
  • By its terms, Rev. Proc. 2007-65 does not apply
    to geothermal, biomass and the other facilities
    eligible for PTCs
  • This is a safe harbor, but be very wary of not
    following it

31
  • In order to comply with Rev. Proc. 2007-65, the
    developer must have a minimum 1 interest in each
    item of partnership income, gain, loss,
    deduction, and credit throughout the term of the
    partnership
  • Also, an investors interest cannot flip down
    to less than 5 of its initial interest

32
  • Under Rev. Proc. 2007-65, there are no calls
    (developers rights to buy out the investors
    interest) in the first 5 years, and no puts
    (investors rights to require the developer to
    buy out the investors interest) at all
  • Any calls must be for not less than the fair
    market value of the interest involved

33
  • In order to comply with the Rev. Proc., as of the
    later of the projects placed in service date or
    the investor admission date, the investor must
    have at least 20 of its total anticipated
    capital invested in the partnership
  • Also, at least 75 of the investors capital must
    be not subject to adjusters

34
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