STATE-MANDATED POWER CONTRACTS remain under a cloud after a US appeals court said in early June that Maryland cannot force utilities to sign long-term power contracts at different prices than the wholesale power prices in PJM, the regional wholesale power market.
The decision was in a case called PPL EnergyPlus, LLC v. Nazarian.
A federal district court reached the same conclusion last fall about a similar capacity auction in New Jersey. The New Jersey decision has been appealed to a different US appeals court than the one that heard the Maryland case.
According to the courts, the state actions violate the supremacy clause of the US constitution because they effectively establish a price for electricity sold at wholesale. The Federal Energy Regulatory Commission has exclusive jurisdiction to regulate the prices for such electricity.
A decision in the New Jersey appeal is expected imminently. The issue could end up before the US Supreme Court, although the court has discretion whether to hear appeals.
The cases are significant beyond Maryland and New Jersey because they may raise questions about the enforceability of other state programs that require utilities to sign long-term power contracts to the extent they affect the price at which utilities must buy wholesale power. The issue is whether any such effects on pricing are so great as to require federal preemption.
TAX CREDITS for renewable energy remain in limbo in Congress.
Senator Harry Reid (D-Nevada), the Senate majority leader, suggested at a press conference in early June that the Senate is unlikely to take up a bill before late November at the earliest to extend the deadline to start construction of new wind, geothermal, biomass, landfill gas and ocean energy projects by another two years through December 2015 to qualify for federal tax credits. Such projects had to be under construction by December 2013 to qualify. The Senate tax-writing committee voted on April 3 to allow another two years through 2015 to start construction. However, Republicans blocked the bill from being taken up by the full Senate after Reid prevented Republicans from offering an amendment to repeal an excise tax on medical devices that is part of the funding for Obamacare.
The construction-start language is part of a broader tax extenders bill that would extend more than 50 tax benefits that expired in 2013 or are scheduled to expire this year.
It is possible Congress will find a way to deal with the issues in a “lame duck” session after the November elections. It is also possible, if the November elections give the Republicans control over both houses of Congress, that Republicans will want to push unfinished business into the new Congress that starts in January 2015 when they will be in control.
Meanwhile, the Internal Revenue Service is expected to release additional guidance in July on how much work had to be done in 2013 for a project to be considered under construction under the “physical work test.” The guidance is being drafted by the US Treasury and is currently expected to take the form of questions and answers.
There were two ways to start construction of projects in 2013. One was by incurring at least 5% of the project cost. The other was by starting physical work of a significant nature.
The tax equity market has largely shut down for projects that relied on physical work while the market waits for the new guidance.
Meanwhile, the IRS has decided not to issue any private letter rulings on construction-start issues after accepting a number of ruling requests and then deciding that they were all too factual.
TREASURY CASH GRANT LITIGATION is moving closer to resolution.
There are 20 pending lawsuits against the US Treasury Department by companies that put new renewable energy facilities in service after 2008 and chose to be paid 30% of the “basis” the companies had in the facilities in cash rather than claim tax credits. All of the companies received smaller cash payments than they applied for. The Treasury was authorized to make the payments under section 1603 of the American Recovery and Reinvestment Tax Act. Many renewable energy projects are financed in a way that lets the owner use the fair market value as his basis for calculating tax benefits (and, by extension, section 1603 payments in lieu of tax credits) rather than the cost to build the project. This has led to many disputes with Treasury about how to determine the value.
The government filed motions for summary judgment in eight of the pending cases in late May. A summary judgment motion is a request for the court to decide the cases based on legal briefs from both parties. The procedure is used in cases where the facts are not in dispute.
It should lead to decisions in at least some of the cases this year.
The oldest case has been pending since July 2012. All of the cases have been filed in the US Court of Federal Claims. One case filed earlier than July 2012 was withdrawn by the solar company that filed it after the government accused the company of fraud.
The remaining cases raise five significant issues.
Many of the suits challenge the Treasury’s cost-up approach to determining value. The Treasury has appeared to base some grant payments on what a project cost to build and then adding a profit margin that it considers reasonable.
At least two suits challenge whether part of what was paid for a utility-scale power project must be allocated to the power purchase agreement with a utility. Any amount allocated to the power contract would not qualify for a grant. The IRS ruled privately in 2012 that a power purchase agreement that can only be performed by supplying electricity from a specific project has no value separate from the project on the theory that the contract is like a tenant lease of a building. No one buying a building would allocate part of the purchase price to the tenant lease. The entire purchase price is treated as basis in the building. The IRS quickly thought better of applying the analogy to power contracts and withdrew the ruling.
The issue in at least one suit is whether the Treasury is required by law to accept what outside appraisers say is the fair market value of a project. Other suits involving projects that were sold to bank leasing companies and leased back raise the issue whether part of what the bank leasing companies paid must be treated as purchase price for an intangible asset like going concern value rather than the power plant. Grants are not paid on intangible assets.
Finally, the latest suit, filed in mid-May, involved a 17.6-megawatt wind farm near the Anchorage, Alaska airport whose developer, Fire Island Wind, LLC, spent $5.3 million to dismantle an old navigational system and buy the air traffic controllers a new Doppler radar so that the developer could get clearance from the Federal Aviation Administration to put up its wind turbines. The developer treated the $5.3 million as a cost of the wind turbines. The Treasury would not let the amount be included in basis for calculating the cash grant on the project.
The statute oflimitations to file suit against theTreasury is six years fromwhen a company is notified its grant has been approved for payment. Ifthe government starts losing some ofthe cases, other suits can be expected.
In a separate development, the IRS said in early June that companies may not claim an investment tax credit to make up for haircuts in grant amounts due to sequestration. Grants approved for payment through September this year are subject to a 7.3% haircut as part of a Congressional budget deal in 2012 to keep the federal government open. Sequestration will continue past September, but potentially at a different percentage.Somedevelopersmust have tried to claimtax credits forthe shortfall.The IRS said this is not allowed.The tax basis the project owner uses to depreciate the project must be reduced by one half the grant. The IRS said the basis reduction is for half the actual grant paid —after sequestration.The IRS announcement is in Notice 2014-39.
REITS can own some solar equipment, the IRS said.
An IRS proposal in early May to make it easier for real estate investment trusts to invest in solar was disappointing, but may not be the last word. The IRS is collecting comments through August 12. The proposal would let REITs that own buildings also own solar panels on the building that are used to supply electricity to the building occupants. It is not clear the proposal would allow REITs to own solar panels in other situations.
REITs are corporations or trusts that do not have to pay income taxes on their earnings to the extent the earnings are distributed each year to shareholders.
The renewable energy industry is interested in REITs potentially as a source of cheaper capital. Congress created REITs in 1960 as a way for small investors to invest in large-scale real estate projects. Small investors pool their investments in the REIT and are treated essentially as if they had invested in the real estate projects directly without a corporate-level tax being taken out along the way.
The challenge for renewable energy is that a REIT must hold at least 75% real property or interests in real property. Examples of such assets are land, site leases, buildings and mortgages secured by real property.
The IRS, with the active encouragement of the White House and Department of Energy, issued proposed regulations in May redefining what qualifies as “real property” for REIT purposes. Under the new definition, solar equipment qualifies as a “structural component” of a building if it performs a utility-like function for the building, such as providing electricity, and the electricity is part of what the building occupants get for their rent for the use of space. In addition, the REIT must own both the solar equipment and the building, and it must expect the solar equipment to remain permanently in place.
The IRS and US Treasury are still thinking about whether it makes a difference if some of the electricity is supplied to the local utility, for example, through net metering. However, in an example showing how the new definition works, the IRS said that a solar system mounted on the ground next to a building whose electricity it supplies is considered a structural component of the building,even though the tenant transfers excess electricity “occasionally” to the local utility.
The IRS said in another example that the land, underground gathering lines, concrete base and metal racks that hold the solar panels in place at a utility-scale project qualify as real property, but the solar panels do not. The agency drew a line around what qualifies at a utility-scale project in the same place as the market already draws it under the existing definition.
Some renewable energy companies have been worried that any expansion of what is considered real property for REIT purposes could undermine other positions the industry has taken. The industry treats solar projects as equipment in order to claim Treasury cash grants, investment tax credits and five-year accelerated depreciation on the projects. These tax benefits can be claimed only on equipment and not also on real property. The US renewable energy sector has attracted a large amount of foreign investment, including by prominent European utilities. These investors are not subject to US capital gains taxes when they exit US projects unless the projects are considered real property.
The IRS said it is redefining real property solely for REIT purposes and said it does not necessarily follow that real property must be defined the same way for these other purposes. It asked for comments on the extent to which the various other uses of the term real property in the US tax code should be reconciled.
The new definition will apply after the IRS republishes it in final form. The agency has scheduled a public hearing on the new definition on September 18.
Any requirement to show that rooftop systems are expected to remain permanently in place would complicate the ability to finance rooftop systems in the tax equity market. A tax equity investor must be able to prove he is the tax owner of equipment to claim tax benefits on it. It is hard to prove tax ownership of equipment that is bolted permanently to the roof of someone else’s house.
A PARTLY CONTINGENT PURCHASE PRICE creates tax complications.
Many developers sell projects that are still under development for cash at closing plus additional payments that are contingent on reaching various milestones.
The developer usually reports its gain under the installment method, meaning the gain is reported over time as payments are received.
IRS regulations require the gain be calculated each year by taking the maximum purchase price the developer might receive and subtracting his basis in the project to determine the fraction of the purchase price that would be gain. The developer then reports that fraction of each actual payment from the buyer as gain.
However, if the maximum purchase price is unclear by the end of the year in which the sale occurs, then the developer is supposed simply to spread its basis in the project ratably over the period that the purchase price will be paid. Thus, for example, if the purchase price might be paid over five years, the developer would subtract 20% of its basis in the project each year from what the buyer pays it that year.
One taxpayer who sold a company got the IRS to rule that it could use a different method for determining how much of each payment was gain. The ruling is Private Letter Ruling 201417006. The IRS made the ruling public in late April.
The buyer agreed to pay cash at closing, assume liabilities and make additional payments over the next seven years tied to growth in company revenues.
Since the ultimate purchase price the seller might pay was too uncertain, but the seller knew it might receive payments for up to seven years, it was required to spread its basis in the company shares it sold ratably over seven years. This would have led to a large gain in year one and a large loss in year seven based on projections the seller made assuming the company would continue to grow at the same rate it had in the past.
Instead, the IRS let the seller allocate part of its basis to each year over the seven-year period in the same pattern as the seller expected to receive contingent payments.
IRS regulations allow the seller to use a different method for allocating basis if it can show that he will probably recover basis at least twice as fast under the alternative and the method is reasonable. The seller must receive IRS approval to use the method by asking for a private ruling.
CORPORATE INVERSIONS are becoming more common.
A corporate inversion is where a US corporation with substantial foreign operations reincorporates in a foreign country to reduce the amount of taxes it has to pay in the United States on its foreign earnings.
A wave of inversions early in the last decade led Congress to take steps in 2004 to discourage them. Now a new wave of inversions has led to new hand wringing on Capitol Hill, but the gridlock in Congress and the lack of consensus about what action to take make any further action unlikely, at least this year.
Forty one US multinational corporations have reincorporated in lower tax countries since 1982. Of that number, at least 13 moved since late September 2010, and another eight inversions were in the works as of late May. Of these 21 transactions, 11 involve reincorporation in Ireland, three in the United Kingdom, three in Holland and one each in Canada, Australia and Germany.
The attraction is not only a lower tax rate — the US corporate income tax rate is 35% compared to 12.5% in Ireland and 20% in the United Kingdom — but also the United States taxes US corporations on their worldwide earnings while the other countries impose limited or no taxes on offshore income. Another factor is the $1.95 trillion in earnings that US multinational corporations have parked in offshore holding companies and are unable to use in the United States without triggering US income taxes. An inversion could make the earnings easier to redeploy.
Congress amended the tax code in 2004 to make it more painful for US companies to invert. In cases where the shareholders of the former US corporation continue to own at least 80% of new foreign parent company by vote or value, the foreign corporation is treated as a US company for tax purposes, so any benefit from inversion is eliminated. If the shareholders of the former US corporation retain at least 60% of the new foreign corporation, then a toll charge is collected on any appreciation in asset value when the company leaves the US tax net. The toll charge cannot be offset by using tax attributes such as net operating losses and foreign tax credits. In addition, some executives of the inverted company may have to pay an excise tax at a 20% rate on the value of their stock options and stock-based compensation when the company leaves the US tax net.
However, a US company can avoid the tax penalties if the affiliated group of companies headed by the new foreign parent company has substantial business activities in the new parent’s home country. In that case, it is not considered to have inverted.
Given these rules, two types of inversions are still possible.
One is a “self inversion” where the US corporation simply reincorporates abroad and has substantial business activities in its new home country. Such inversions are rare. The IRS interpreted substantial business activities in 2012 to mean at least 25% of the affiliated group’s sales, assets, income and employees must generally be in the country where the new foreign parent corporation is incorporated.
Most recent transactions involve mergers of a US and foreign corporation where the shareholders of the foreign corporation continue to own more than 20% of the combined entity. In the typical “acquisition inversion,” the US company combines with a smaller foreign company. The combined company can choose a third country as its new tax home. The executive team usually remains in the United States.
The chairman of the Senate tax-writing committee, Ron Wyden (R-Oregon), said in an op-ed piece in the Wall Street Journal in early May that he plans to try to put a halt to inversions by merger by requiring the shareholders of the foreign corporation to own at least 50% of the combined entity. This would leave the door open only to mergers of equals or takeovers of US corporations by larger foreign corporations.
Chiquita Brands International is moving overseas in a merger with Irish rival Ffyfes PLC, which is based in Ireland. The combined company will be a tax resident of Ireland. Chiquita shareholders would own 50.7% of the combined company. The deal is not expected to close until later this year.
Neither Orrin Hatch (R-Utah), the ranking Republican on the Senate tax-writing committee, nor Dave Camp (R-Michigan), the chairman of the House tax-writing committee, joined Wyden in threatening action. Republicans say the only way to stop inversions is to reduce US corporate income taxes to bring them in line with lower taxes in other countries.
This is in contrast to 2002 when Senator Charles Gras sley (R- Iowa) , then rank ing Republican on the Senate tax-writing committee, joined the committee chairman, Max Baucus (D-Montana), in a joint statement that Congress would act to shut down inversions effective the day of the statement: March 21, 2002. However, the final bill did not become law until 2004, by which time there was a new Congress. Thus, the final effective date slipped to a date early in the new Congress: March 4, 2003.
The Wyden proposal is similar to a proposal that the Obama administration made in its budget message to Congress in March. Senator Carl Levin (D-Michigan) and his brother, Congressman Sander Levin (D-Michigan), the ranking Democrat on the House tax-writing committee, intro-duced nearly identical bills in May to do the same thing. The bill would also continue to treat a re-domiciled company as a US company for tax purposes if it remains managed and controlled from the US and at least 25% of its employees, employee compensation or assets are located or derived in the United States.
Meanwhile, the IRS tightened the existing rules in late April by issuing a notice that said inversions would trigger US toll charges on US shareholders who receive shares in the combined new company as consideration for their shares in what was formerly treated as a “killer B” tax-exempt reorganization. The notice is Notice 2014-32.
The popularity of re-incorporations in Ireland is starting to worry the Irish government, as it could undermine Ireland’s insistence that it is not a tax haven. Some companies that have set up tax residence in Ireland use a “double Irish” structure to shift profits from Ireland to Bermuda to reduce taxes even further.
CHILEAN PROJECTS are expected to face higher taxes.
A tax reform bill that Chilean President Michelle Bachelet submitted to the National Congress in April would increase the corporate income tax rate from 20% to 25% over four years. The new rates will be 21% in 2014, 22.5% in 2015, 24% in 2016 and 25% in 2017.
The bill is expected to be approved in September.
It would also impose thin capitalization rules that will limit the extent to which developers can “strip” earnings from Chilean projects by pulling them out as interest on shareholder debt. In the future, interest paid by a Chilean company on loans from related parties would be re-characterized as dividends to the extent the company has a debt-equity ratio of more than three to one. Debt from third parties would be counted in determining whether the company is too highly leveraged, but the only interest that would be treated as dividends is interest on loans from related parties.
Jessica Power, co-head of the tax group at Carey, a premier law firm in Santiago, said the company would also be treated as having too much debt to the extent interest and other financing costs in a year exceed 50% of the company’s taxable income before deducting such costs. The thin capitalization rules would apply starting on January 1, 2015. They will apply to existing shareholder loans, said Power.
Many developers capitalize Chilean project companies with debt in an effort to reduce the Chilean taxes on their projects. By distributing earnings as interest on such loans, the project company can deduct the distributed earnings, and interest paid cross border attracts a lower withholding tax — 4% or 15% depending on the facts — compared to 35% on dividends. These are the statutory withholding rates. Actual withholding may be lower where the developer is a tax resident of a country with a favorable tax treaty.
The tax reform bill would also move to taxing shareholders in Chilean companies on their shares of company earnings in the year the earnings accrue even if the earnings are not distributed until later. Earnings would be considered to accrue even before a dividend is declared, according to Jessica Power. Thus, this would have the effect of taxing shareholders on earnings that a company retains for reinvestment.
Expenses on transactions with related parties — for example, interest on shareholder loans — would be deductible only in the year actually paid.
Interest on loans to acquire equity interests or bonds could not be deducted. Rather, it would have to be capitalized into the basis in the equity or debt instruments acquired. This would not apply to borrowing to acquire assets.
A carbon tax would be imposed on emissions from any boiler or turbine with a capacity of at least 50 megawatts. The tax would be a minimum of the Chilean peso equivalent of US$0.10 per ton of particulate matter, nitrogen oxide or sulfur dioxide emitted, according to Manuel José Garcia with Carey. The tax rate could be higher under a formula tied to the concentration of pollutants in the local area. The tax on carbon dioxide emissions would be US$5 a ton. The tax would be an annual levy payable for the first time in April 2018 on 2017 emissions.
A stamp tax collected on loans would increase from the current range of 0.033% to 0.4% to flat tax of 0.8% for any loan with a term of more than two months.
ROOFTOP SOLAR has the potential to take away about 7% of retail electricity sales from US utilities, according to a report by Bernstein Research, an independent Wall Street research firm, in early June.
The figure is only 2% if the current 30% investment tax credit for solar equipment drops to 10% after 2016 as currently scheduled and only 1.6% if the credit is eliminated. All three estimates assume that the cost of the average US solar rooftop installation will fall to $2.20 a watt compared to about $4.60 in the fourth quarter 2013. The figure $2.20 is what the average solar system cost late last year in Germany.
Distributed solar generation today is just 0.2% of US electricity supply, leaving significant room for growth under any of the forecasts.
More than 75% of current distributed solar capacity is in five states: Hawaii, California, Arizona, New Jersey and Massachusetts. The fact that the amount of sunlight varies so significantly in the five states speaks to the importance of retail electricity rates and state incentives in driving rooftop installations.
Bernstein estimated the highest possible percentage of distributed solar penetration in the US is 24% assuming universal deployment by all residential, commercial and industrial customers. However, nearly 50% of residential properties may not work for solar because of shade and other physical barriers.
It calculated utility by utility which customers have the greatest incentive to install solar given retail electricity rates and the potential savings. The 11 utilities facing the greatest danger and the percentage of retail electricity sales each could lose are as follows: Arizona Public Service 34%, Public Service Company of New Mexico 31%, Pacific Gas & Electric 26%, San Diego Gas & Electric 25%, United Illuminating Company 25%, Southern California Edison 23%, Northeast Utilities 21%, Hawaiian Electric Companies 20%, Central Hudson 15%, Consolidated Edison 14% and SCANA 14%.
Several of these utilities are protected by state regulatory regimes that decouple the utilities’ revenue from electricity sales. If sales fall below the forecast, then the regulators must allow the utility to increase what it charges per megawatt hour of electricity to stabilize revenues at the target level.
The move to rooftop solar could also affect prices for fossil fuels. According to Bernstein, 7% of US demand for natural gas is at risk as well as 3% of US demand for western coals and 1% of demand for eastern coals.
A EUROPEAN FINANCIAL TRANSACTIONS TAX moves closer.
Finance ministers from 10 countries said in a joint statement in May that their countries will impose a financial transactions tax starting January 1, 2016. The 10 countries are Austria, Belgium, Estonia, France, Germany, Greece, Italy, Portugal, Slovakia and Spain. The tax will apply initially to transfers of shares and other equity instruments and to some derivatives transactions and then be expanded over time. The countries are expected to finalize details of the tax by the end of this year.
The European Union has been talking about such a tax since September 2011. The original proposal was for a tax of at least 0.1% on the trading of shares and bonds and a tax of at least 0.01% on derivatives. For cross-border transactions between one party in a country with the tax and another in a country without the tax, the party in the country with the tax would be expected to pay the tax for both parties.
The United Kingdom and Sweden oppose the tax and have complained about its extraterritorial reach.
France and Italy have moved ahead in the meantime with a tax without waiting for the other countries. France has been collecting a 0.2% tax on acquisitions of shares in Frenchlisted companies with market capitalizations of more than €1 billion since August 1, 2012. Italy began imposing a tax on transfers of shares and other equity positions on March 1, 2013.
EFFORTS TO SLOW RENEWABLE ENERGY fail in three states, but lead to a freeze in one.
An organization backed by the wealthy Koch brothers has been making a concerted push to roll back renewable energy standards that require utilities to supply a certain percentage of their electricity from renewable energy in 29 states and the District of Columbia. The effort has been running into opposition from some Tea Party groups that see distributed generation as a move toward democratization of the electricity supply.
In Oklahoma, the lower house in the state legislature failed in May to take up a bill that would have imposed a three-year moratorium on construction of new wind farms in the eastern third of the state, effectively killing the bill for the current session. The bill passed the state Senate by 32 to 8 in March.
The Kansas house failed in early May by a vote of 60 to 63 to phase out the state renewable portfolio standard. The current standard requires utilities to supply 20% of their electricity from renewable energy by 2020. An effort to repeal the standard failed earlier in the year. The latest vote was on a compromise to increase the current 10% target to 15% in 2016 and then to eliminate the target after 2020.
A federal district court in Colorado rejected claims in May by the Energy and Environment Legal Institute that the Colorado renewable portfolio standard violates the commerce clause of the US constitution. The Institute argued that Colorado is effectively forcing its policies on electricity generators in neighboring states who want to supply electricity to Colorado utilities, thereby inhibiting interstate commerce. The court did not buy the argument. The case is Energy and Environment Legal Institute v. Epel.
TheOhiolegislature votedinMay tosuspend its renewable portfolio standard for two years while a legislative panel studies the issues. The state requires utilities to supply at least 25% of electricity from renewables by 2025. The action freezes the target at current levels through 2017. Ifthe legislature takes no further action afterthe panel reports its findings, then the 25% target would be reinstated, but utilities would have another two years until 2027 to comply.
A TAX PLANNING MEMO was not privileged and had to be disclosed to the IRS after the company shared the memo with its lenders.
The memo, written by Ernst & Young, analyzed the tax consequences of a corporate restructuring and weighed the strength of possible IRS challenges.
A federal district court in New York ordered the memo turned over to the IRS in late May in a case called Schaeffler v. United States. The case is now before a US appeals court.
George F.W. Schaeffler owned 80% of a three-tier chain of companies headquartered in Germany that manufacture and distribute bearings and other automotive and industrial components.
The group made a tender offer for shares of Continental AG, another German auto and industrial parts supplier. It expected to acquire less than 50% of the shares, but ended up buying 89.9% at €70 to €75 a share for a total cost of €11 billion. The acquisition closed in July 2008. Over the next seven months, the share price plummeted to €11 a share. The acquisition was financed by a consortium of banks. The falling s h a r e p r i c e l e f t t h e Schaeffler group close to insolvency and forced it to refinance the debt and restructure.
Schaeffler hired Dentons and Ernst & Young to help figure out a plan and advise on the tax consequences. The restructuring took place over the period 2009 to 2010. Ernst & Young wrote a long tax planning memo as part of the process.
Schaeffler received a favorable private letter ruling about the transaction from the IRS in August 2010. The favorable ruling did not stop the IRS from auditing the 2009 and 2010 tax years of the company in 2012. The IRS asked for all “tax opinions and tax analyses that discuss the US tax consequences of any or all of steps of the restructuring,” and it issued a separate administrative summons to Ernst & Young directly for “all documents created by Ernst & Young” that relate to the refinancing and restructuring.
Both the company and Ernst & Young responded that the tax memo was privileged.
US tax law recognizes two types of privileges. One is for attorney-client communications about legal matters. Section 7525 of the US tax code extends this privilege to communications between a client and a “federally authorized tax practitioner.” The other privilege is a workproduct privilege for documents prepared in anticipation of litigation.
Both privileges may be lost if documents are shared with third parties.
The bank consortium and Schaeffler entered into an “Attorney Client Privilege Agreement” during work on the transaction in which they expressed a desire to share confidential documents and analyses of the transaction without waiving privileges. The Ernst & Young memo was shared with the bank group. The banks agreed to let Schaeffler pay up to €885 million in personal tax liabilities ahead of repaying the debt.
The court said the memo lost any attorneyclient privilege when it was shared with the lenders. The privilege would not have been / continued page 36 waived if the memo had been shared as part of an effort by the parties to formulate a common legal strategy, but theirs was a commercial interest rather than a common legal interest. An example of a common legal interest is where the parties could become co-parties in litigation.
In contrast, any work-product privilege for the memo was not waived by sharing the memo with the banks. The work-product privilege is waived only “when the disclosure is to an adversary or materially increases the likelihood of disclosure to an adversary,” the court said. The parties took steps to prevent the memo from falling into the government’s hands by marking it confidential and entering into the joint sharing agreement.
However, the court said there was no workproduct privilege for the memo since the memo was not prepared in anticipation of litigation.
Schaeffler argued it had good reason to expect an IRS audit and eventual litigation. The memo ran through the transaction steps and their potential tax consequences, but — the court said — there was no discussion of any litigation strategy. It was a transaction memo rather than a litigation memo.
MORE SOLAR PANELS from China and Taiwan will be subject to US import duties, the US Department of Commerce said in early June.
The duties are “countervailing” duties of 18.56% for panels made by Trina Solar, 35.21% for Suntech panels and 35.21% for panels from other manufacturers. These are preliminary figures. The final duties will be settled in the fall.
Importers must begin posting cash deposits immediately to cover the duties. The Commerce Department is expected to announce by July 24 whether additional “anti-dumping” duties will also be imposed on the products.
SolarWorld, which filed the complaint that led to imposition of duties, says the Chinese solar panels in question are being dumped in the United States at 165.04% below their price in other markets. It says the dumping margin on the affected Taiwanese panels is 75.68%. This suggests that the additional, anti-dumping duties could be large. The US already collects duties of 23.75% to 254.66% on imported Chinese solar cells. The new duties apply to a different set of products: Chinese and Taiwanese solar modules made with cells “completed or partially manufactured” outside the country where the modules are completed. SolarWorld complains that the existing duties on Chinese solar cells are being circumvented by making solar panels in China using cells made in Taiwan. Reports suggest that as many as 70% of Chinese solar panel manufacturers that export panels to the United States use cells made in Taiwan. The existing duties do not cover Chinese modules made with non-Chinese cells.
Although the latest duties also apply to solar panels made in Taiwan, a questionnaire that was sent to solar panel manufacturers in China and Taiwan has led to speculation that solar modules manufactured and assembled in Taiwan without Chinese solar cells may be dropped from the case. The questionnaire asked manufacturers whether their cells are produced partly in China.
The US government is under pressure from US solar companies that use Chinese panels to try to work out a settlement with the Chinese government.
Duties must be paid by the US importer of record. The preliminary duties announced in early June are subject to adjustment later in the year. A final decision on the duties is not expected before mid-October at the earliest. US importers are retroactively liable for any difference plus interest if the final duties are higher than the preliminary amounts.
Under US tariff law, if the foreign manufacturer reimburses its customer for the duty, then the reimbursement is itself collected as an additional duty.
ARIZONA will start collecting property taxes in 2015 from solar companies that retain ownership of rooftop solar systems and lease them to customers after an effort failed in the legislature to overturn the tax.
The tax is expected to run $152 a year for a typical system, eating up about 42% of the $360 in annual savings a homeowner realizes by adding solar. Leases may require homeowners to reimburse the solar company for such taxes.
By statute, a system that a homeowner owns and uses to generate electricity for his own use is not considered to add to the value of the house for property tax purposes. The Arizona Department of Revenue said in a 2013 memo that this provision does not provide any relief from property taxes to a solar company that owns a system independently from the house.
The solar company must value the system for property tax purposes at 20% of its depreciated cost.
ETHANOL PLANTS must be depreciated over seven years, the IRS said in May.
Some ethanol producers have been depreciating their plants over five years on the theory that the plants are used to produce chemicals. Assets used for the “manufacture of chemicals and allied products” belong in asset class 28.0 and may be depreciated on an accelerated basis over five years.
However, the IRS said such plants belong in a different asset class, 49.5, used for “waste reduction and resource recovery plants” as this category includes equipment used to “process . . . biomass to a . . . liquid . . . fuel.” The difference in depreciation is worth 2¢ per dollar of capital cost. The loss in tax subsidy to a typical ethanol plant is about $4 million.
The IRS made the announcement in Rev. Rul. 2014-17. The ruling described a facility that produces ethanol from corn and sells carbon dioxide as a by-product.
The latest ruling does not come as a surprise. The IRS released an internal legal memo in 2008 suggesting that it was challenging ethanol producers on their depreciation.
AN INDIVIDUAL WAS AT RISK for half a loan even though he was unlikely to have to pay on his guarantee of the loan and may not have been able to do so.
Michael Moreno used a limited liability company he owned to buy a Learjet for $7.9 million. The LLC borrowed the full purchase price from GE Capital. Both Moreno and another company with substantial assets of which Moreno owned 98% guaranteed repayment of the loan. It appears that the LLC was a disregarded entity for tax purposes.
Moreno claimed $4.775 million in depreciation on the jet in the year the LLC bought it. The IRS disallowed the amount because it said Moreno was not at risk for the purchase price. Individuals, S corporations and closely-held C corporations, meaning corporations in which five or fewer shareholders own more than half the stock, can claim losses only to the extent such taxpayers are at risk. Ordinarily, the fact that an individual personally guaranteed repayment of a loan used to pay the purchase price means the individual is at risk.
The IRS said the guarantee in this case was illusory.
It pointed to internal GE Capital memos showing that GE Capital looked solely to the other, corporate guarantor and did not mention Moreno as a possible source of repayment when evaluating whether to make the loan. The IRS also said Moreno had only $11,537 in liquid assets at the time. Moreno said he had a net worth of $27 million consisting largely of shares in another company. Finally, the IRS said that because Moreno owned 98% of the corporation that was the other guarantor, he would make sure it paid on its guarantee before he had to do so.
A federal district court in Louisiana held in late May for Moreno. It said the government cited no legal authority that a guarantor must have liquid assets to support its guarantee. Liquidity of assets is not the test. It said the government also cited no authority for its proposition that where there are two sureties, and the evidence shows the lender was looking only to one, the guarantee of the other is ignored.
The court treated Moreno as at risk for half the loan because of cross indemnities requiring each guarantor to reimburse the other if there is a claim. The case is Moreno v. United States.
MINOR MEMOS.The IRS may withdraw a private letter ruling it issued in 2012 that said investment tax credits can be claimed on solar projects owned by Indian tribes. The ruling involved an inverted lease transaction. The issue is whether such a project is “used by” the tribe. At least two IRS branches are recommending withdrawing the ruling. The ruling is Private Letter Ruling 201310001 . . . . An IRS branch chief warned that the agency is looking more closely at captive insurance pools. If participants in such a pool are required to repay the pool with interest for any claims that are paid by the pool, then the pool is not really insurance and “premiums” paid to it are not deductible. The branch chief, Sheryl Flum, made the comment during an American Bar Association webinar in late May.