This memo describes briefly a number of important provisions of the American Recovery and Reinvestment Act of 2009 (“ARRA”) that are designed to stimulate investment in renewable energy projects. These provisions, which provide for cash grants, the extension and expansion of important tax benefits associated with investing in renewable energy projects, and the extension and expansion of a significant government loan guarantee program, should be of interest to developers and owners of energy projects, as well as companies that supply them and the advisory firms that assist them.
I. Treasury Grant
On July 9, 2009, the United States Department of the Treasury released the terms and conditions, guidance materials and a sample application for the making of grants (“Grants”) under Section 1603 of ARRA to owners and developers of renewable energy projects. 1 Congress has authorized U.S. $3 billion of funding for the program. A Grant can be collected in lieu of a production tax credit (“PTC”) or an energy tax credit (“ETC”) otherwise available under section 45 and section 48 of the Internal Revenue Code (the “Code”). The Grants permit the prompt recovery of up to 30% of the cost of eligible property, do not require that the person obtaining the grant have taxable income and are not tied to the amount of actual energy production.
Grants are available for “Specified Energy Property” (“SEP”) which includes the following:
- wind facilities
- biomass facilities
- landfill gas facilities
- trash facilities
- qualified hydropower facilities
- marine & hydrokinetic renewable energy facilities
- qualified fuel cells
- solar energy
- certain geothermal projects
- combined heat & power systems
- geothermal heat pumps.
Eligible property under the program includes only property used in a trade or business or held for the production of income. The amount of the Grant awarded is dependent on the type of SEP put into service. In general, the Grant will equal 10% or 30% of the cost basis of the property.
B. Applicant Eligibility
The applicant must be the owner or lessee of qualified SEP and must be the original user of the property. Where the applicant is the lessee of the SEP, it must have written consent from the owner which must waive its right to receive any Grant, as well as its right to claim any PTC or ETC with respect to the property.
The Treasury is prohibited from making grants to:
- the Federal or any State or local government (or any political subdivision, agency, or instrumentality thereof);
- any organization described in Section 501(c) of the Code and exempt from tax under Section 501(a) of the Code;
- an entity referred to in section 54(j)(4) of the Code, 2
- any partnership or other pass-through entity having one of the categories of entities described above as a partner (or other holder of an equity or profits interest therein) unless this person only owns an indirect interest in the applicant through a taxable C corporation; and
- a foreign person or entity unless it is a foreign person or entity that qualifies for the exception in section 168(h)(2)(B) of the Code (that is, in general, a foreign person subject to U.S. income tax).
As long as each direct and indirect partner in a partnership or shareholder or similar interest holder in any other pass-thru entity is eligible to receive a Grant, the partnership or pass-thru entity is eligible to receive a Grant.
C. Terms and Conditions
1. Placed in Service
To receive a Grant, the qualified property must be placed in service between January 1, 2009 and December 31, 2010 (regardless of when construction begins), or placed in service after 2010 but before a specified “Credit Termination Date” if construction of the property begins between January 1, 2009 and December 31, 2010. The Treasury has set forth specific guidelines and safe harbors respecting when construction is deemed to begin. The application for the grant must in all events be received before October 1, 2011.
2. What Property Constitutes Specified Energy Property
The Treasury has indicated that “only the portion of a facility that is described in section 48 of the Code is taken into account in computing the Section 1603 payment.” As an example, the Treasury cited the case of a building with solar property on its roof: only the cost of the solar property and the cost of mounting qualify for the purposes of the Grant calculation; the cost of the building does not qualify. SEP includes only tangible property, and is property for which depreciation (or amortization in lieu of depreciation) is allowable. The Treasury has further indicated that qualified property includes only tangible property that is both used as an integral part of the activity performed by a qualified facility and is located at the site of the qualified facility.
3. Eligible Basis
The basis of property for the purposes of the Grant will be determined in accordance with the general rules for determining the basis of property for federal income tax purposes.
4. Leased Property
Any eligible lessor may elect to pass-through the Grant to a lessee that is eligible to receive a Grant. Such an election will treat the lessee as having acquired the property for an amount equal to the independently assessed fair market value of the property on the date the property is transferred to the lessee. The lessee must also agree to include ratably in gross income over the five year recapture period (discussed below) an amount equal to 50% of the amount of the Grant.
The Treasury has provided a special rule for sale-leaseback transactions. In such a case, a lessee may claim a Grant only if three conditions are satisfied: (i) the lessee must be the person who originally placed the property in service; (ii) the property must be sold and leased back by the lessee, or must be leased to the lessee, within three months after the date the property was originally placed in service; and (iii) the lessee and lessor must not make an election to preclude application of the sale-leaseback rules.
5. Recapture of Grant Amounts
If a recipient of a Grant disposes of the property to a disqualified person or the property ceases to qualify as SEP within five years from the date the property is placed in service (a “disqualifying event”), 100% of the Grant amount must be repaid to the Treasury if the disqualifying event occurs within one year from the date placed in service, with the amount of recapture declining for disqualifying events by 20% in each year, thereafter.
(a) Assignment of Payment
Applicants may submit a Notice of Assignment, assigning the payment to a third party provided the requirements of the Federal Assignment of Claims Act (31 U.S.C. 3727) are met.
(b) Treatment of Payments as Taxable Income
Except with respect to leased property, the amount of the Grant awarded to an applicant will not be included in gross income. The adjusted tax basis of the property will be reduced by an amount equal to 50% of the payment. Thus, for SEP that qualifies for a Grant equal to 30% of its basis, a reduction of 15% of basis is required, and the remaining 85% of cost is subject to depreciation under existing provisions of the tax code.
Applicants will be required to provide reports on an annual basis as required by the Treasury.
(d) Time of Payment of Grant
The Treasury Secretary must pay the grant during the 60-day period beginning on the later of (i) the date of the application for such grant or (ii) the date the SEP for which the grant is being made is placed in service.
II. Bonus Depreciation
The ARRA also extended first-year bonus depreciation under section 168(k) of the Code for capital expenditures related to property placed in service in 2009. Pursuant to that provision, an owner of qualifying property placed in service in 2009 may deduct 50% of the cost of such property (or a reduced percentage if an owner also elects the ETC). The remaining 50% would be depreciated over the regular tax depreciation schedule for subsequent years.
III. Investment Credit
Prior to the ARRA, the only utility-scale renewable energy projects qualifying for the ETC were solar projects. Thus, ETC has not been widely utilized for utility-scale renewable energy projects. Owners of ETC qualified projects receive a tax credit in the year the project goes into service equal to 30% of the tax basis of the project.
The ARRA expanded the ETC to include utility-scale wind energy projects and allows renewable energy facilities that qualify for the PTC to instead apply for a 30% ETC, provided the facility is placed in service in 2009 or 2010. The ARRA also allows the full 30% credit for small wind generators. In addition, the ETC and accelerated depreciation are now available for equipment used to manufacture renewable energy components and systems.
Although investors are precluded from claiming a Treasury Grant along with an ETC with respect to a particular property, the ARRA does permit the use of the full amount of the ETC even if the project receives subsidized financing such as below-market-interest loans or state grants.
IV. Production Credit
Prior to the ARRA, the PTC was the primary federal tax incentive for utility-scale renewable energy projects. The PTC provides the generator with (at the 2009 level) 2.1 cents of tax credit per kilowatt-hour of electricity produced and sold to third parties. A project is eligible for the PTC for a period of 10 years from the date it is placed in service, and there is no production limit with respect to the amount of compensation a project may receive within those ten years. The ARRA has extended the sunset for PTC for wind energy projects through 2012 and for solar projects through 2013.
As the PTC is based on electricity generated and sold, the generator assumes the risk that actual generation deviates from projected levels. Furthermore, the PTC faces the same hurdle as the ETC given that it is a tax credit and not a grant: a taxpayer must have a sufficient tax liability above the credit to receive the full benefit of the credit. To circumvent this problem, developers may finance projects through tax equity financings, where an entity with sufficient tax liability contributes equity to a project in exchange for the right to, among other things, the PTC generated by the project.
Investors electing to accept a Grant must forego ETC. The Grant is a cash grant, and therefore the tax liability of the project owner is irrelevant; the Grant is not production-based, and thus there is no production risk; and the Grant is awarded within a few months after an application is filed by a qualified project, whereas the PTC is recovered over a 10-year period based on actual production. On the other hand, the aggregate benefit from the PTC could exceed the amount of the Grant.
V. Loan Guarantee Program
The ARRA extended the authority of the Department of Energy (“DOE”) to issue loan guarantees and appropriated U.S. $6 Billion for this program. The ARRA amended the Energy Policy Act of 2005 by adding a new section defining eligible technologies for the guarantees and allowing the DOE to enter into guarantees until September 30, 2011. Prior to the ARRA, only “new or significantly improved technologies” were eligible for a guarantee, as compared to technologies already in service in the U.S. at the time the guarantee was issued.
The ARRA Temporary Loan Program removed the requirement that a project use technology that is new or significantly improved in comparison to technologies already in commercial use, and added component manufacturing projects to the list of eligible projects. Under the Temporary Program, the following categories of projects are eligible for guarantees:
- renewable energy systems that generate electricity or thermal energy, and facilities that manufacture related components,
- electric power transmission systems, and
- leading edge biofuel projects.
The changes to the program made by the ARRA aim both to expand the scope of eligible projects under the program and to facilitate the loan guarantee process. The DOE has announced that they are committed to streamlining the review process of applications. It has also indicated that it hopes to spend more than half of the appropriation money in the first year of the program.
The DOE released the first two solicitations under the Temporary Loan Guarantee program on July 29, 2009: (i) renewable energy projects and (ii) electric power transmission projects. Both solicitations have an application deadline of September 14, 2009.
The material requirements for the Temporary Loan Guarantee Program are materially the same as those that were applicable prior to the ARRA, including:
- The guaranteed loan cannot exceed 80% of the total project cost.
- The term of the guaranteed loan will be less than or equal to the shorter of 30 years or 90% of the project’s expected useful life.
- The eligible project must be located in the United States, but foreign sponsorship of a project is permitted.
- If the DOE guarantees 100% of the project’s debt, then the Treasury’s Federal Financing Bank must be the lender.
- If the DOE guarantees more than 90% of the project’s debt, then the guaranteed portion of the debt cannot be separated or “stripped” from the non-guaranteed portion of the debt for syndication or resale in the secondary market.
- The borrower must grant to the United States a first priority security interest in the project’s assets; provided, however, the DOE has determined that it has the authority to enter into intercreditor arrangements when it does not guarantee 100% of the project debt.
In addition to the prior requirements, guarantees under the ARRA must also comply with two additional requirements: (i) the project must commence construction on or before September 30, 2011 and (ii) the project must create or retain jobs in the United States. A further beneficial change to the program under the Temporary Program is that project companies are no longer required to pay the Credit Subsidy Cost as Congress has appropriated funds to so.
A requirement that survived from the initial program to the Temporary Program is that the project company must have sufficient funds (i.e. debt plus equity) to complete the project. The DOE will continue to require equity support for the project and is expected to favor projects with more significant equity support.
Although it is clear that the Grant, the ETC, and the PTC are mutually exclusive, the Treasury Grant and the Temporary Loan Guarantee program are not preclusive of each other. However, the interface between the loan guarantee and the Grant with respect to how a project will be evaluated in program applications will likely evolve over time.