In Chief Counsel Advice (CCA) 20161101F, dated December 3, 2015 and released to the public on March 11, 2016, the IRS advised that the taxpayer was not entitled to a tax credit under Section 45 because the taxpayer was not a bona fide partner in the business. Although the CCA memorandum is heavily redacted, the transaction involved an investment in a limited liability company (LLC) taxed as a partnership, which was formed to own and operate a facility for the production of refined coal. Under the LLC agreement, the taxpayer was obligated to make future investments that were contingent on the amount of coal produced. In addition, there was an indemnification provision requiring indemnification of lost tax credits and deductions, and, if a “tax event” occurred, members with an aggregate threshold interest could suspend coal production. The promotional materials quantified the amount that potential investors would pay for tax credits. Finally, there was no mark-up on the sale of the refined coal to the utility, so the IRS said there was no possible return on investment aside from the tax credits.
Applying the reasoning in Historic Boardwalk Hall LLC v. Commissioner, the IRS concluded that the taxpayer lacked significant downside risk or significant upside potential in connection with its investment in the coal refinery operation, and, therefore, the taxpayer did not acquire a bona fide partnership interest.
This CCA appears to be part of the IRS’s growing scrutiny of taxpayers engaged in transactions involving Section 45 tax credits and other similar energy tax credits. Taxpayers should be aware that the IRS is challenging these transactions, even when the transactions follow industry standards and comply with statutory requirements. In these cases, the IRS has taken one of two approaches: (1) as in CCA 20161101F, the IRS has applied Historic Boardwalk to argue that the investors who purchased partnership interests were essentially purchasing tax credits and, therefore, were not bona fide partners; and (2) the IRS has attacked the partnership under a sham partnership theory arguing that the partnership had no reasonable prospect of economic gain and no subjective nontax purpose, because the taxpayers’ enterprise existed for the sole purpose of monetizing the tax credits.
The IRS’s stance regarding these transactions is at odds with the legislative history of Section 45 and similar tax credits that demonstrate these credits are tax benefits that Congress intended to provide as a subsidy. Transactions taking advantage of that subsidy do not constitute an “abusive tax shelter” or “sham.” Indeed, recognizing this legislative intent, courts have relaxed the profit motive requirement to allow for those tax-motivated transactions that are within the contemplation of Congressional intent. See Sacks v. Comm’r, 69 F.3d 982 (9th Cir. 1995); Horn v. Comm’r, 968 F.2d 1229, 1231 (D.C. Cir. 1992).
It appears the IRS does not acknowledge the fact that Congress contemplated a tax benefit should be made available to taxpayers making such investments if the investments may not otherwise provide a potential for economic return. Accordingly, taxpayers who find themselves under scrutiny for claiming these credits may be asked to demonstrate a profit motive, even for transactions typical in the industry and consistent with the statutory language.
For previous DTU coverage of this field attorney advice, click here.