INDIA is asserting the right to tax multinational corporations that make capital contributions in exchange for shares in Indian subsidiaries to the extent the shares are worth more when issued than the contributed capital.

Both Vodaphone and Shell said in February that they received transfer pricing adjustments by the Indian tax authorities. A Vodaphone holding company in Mauritius subscribed for shares in Vodaphone India for 8,000 rupees ($150) a share that the Indian authorities said were worth 50,000 rupees each ($934). Indian authorities hit the telecom company with a 13 billion rupee ($243 million) transfer pricing adjustment.

Shell was hit with a transfer pricing adjustment of 152.2 billion rupees ($2.86 billion) after an equity subscription by Shell Gas BV in Holland in shares of Shell India.

Both companies said they will fight the adjustments. India views the share subscriptions as outbound transfers of unreported value. The companies view themselves as simply having made capital contributions to their subsidiaries.

PARTNERSHIPS may be subject to new tax rules in the future.

The staff of the House tax-writing committee released a discussion draft in March of a complete rewrite of the US tax rules for partnerships.

The draft is the third in a series of discussion drafts that the staff has been releasing for comment as it works out possible elements of a major corporate tax overhaul. The other two discussion drafts released earlier dealt with tax treatment of US multinational corporations on income earned outside the United States and the tax treatment of derivatives, like futures and forward contracts, swaps and options.

The rewrite of the partnership tax rules would apply starting next year, assuming Congress finds time to take up major tax reform in 2013. However, most lobbyists think any tax overhaul is unlikely to be enacted before next year at the earliest.

The new rules could affect some existing tax equity transactions structured as partnerships. There are no transition rules in the draft. These are usually not added until a bill starts moving through the tax-writing committees and to the House and Senate floors.

The discussion draft would eliminate any distinction between partnerships and S corporations (a form of passthrough entity used by small businesses). Instead, an entity would either be a “passthrough” or a “corporation” for tax purposes. Taxpayers could elect to treat corporations as passthroughs, but this election would not be available for any publicly-traded corporation, bank or insurance company. “Publicly-traded” is broadly defined.

Passthroughs would have to withhold taxes on the income allocated to partners. The rate has been left blank.

The partners would have refundable income tax credits for the withheld taxes.

Partnerships would not be able to make special allocations of depreciation or other elements that go into the calculation of ordinary income. However, tax credits could be allocated in a different ratio than other partnership items. Allocations to each partner would have to be consistent with the partner’s “economic interest.” The term is not defined.

The draft is unclear about whether master limited partnerships would be able to continue operating as passthroughs. However, the staff director of the House tax subcommittee said in an email that the issue was simply beyond the scope of the draft. “Changes to the tax rules governing those specific regimes (in the context of tax reform) are a discussion for another day.”

The draft is one of two options the committee is considering for partnerships. The other option is a list of incremental changes rather than a wholesale rewrite.

THE SECTION 1603 PROGRAM remains an area with lots of activity.

A solar company that sued the Treasury for failure to pay grants on its solar systems mounted on the backs of flatbed trucks agreed in March to drop the lawsuit “with prejudice,” meaning the suit cannot be reinstituted. The company had claimed tax bases in its systems for calculating grants as high as $45 a watt. The US government had filed a counterclaim accusing the company of filing false claims. Five other suits are still pending against Treasury.

The US attorney in New York sued a company, The Excelsior Packaging Group, in early April to recover a $129,111 grant that the Treasury paid the company in January 2010. The company failed to file annual reports confirming that it still owned and is using its renewable energy project. The company failed to respond to multiple demand letters and efforts by a private bill collection agency.

The Treasury is taking aim at the tax bases claimed in sale-leasebacks with low rent coverage ratios. It believes that leases that set rent at only 1.0 times the revenue the lessee earns are being used by lessors to justify inflated purchase prices and, therefore, higher cash grants.

It has set new caps of $4 to $6 a watt on basis in emails to solar rooftop companies. The new caps apply to solar equipment put in service on or after October 1. The caps vary by company because the Treasury is using the income method and customer terms vary, but it raises questions about fairness since the effect is to pay grants of varying amounts to companies that may be direct competitors and are using identical equipment.

The Treasury says that rights to cash grants do not carry over where a developer contributes stockpiled 2011 equipment to a project company and then sells the project company during construction, unless the project is well advanced by the time of sale. The project company cannot be mere wrapping paper for the stockpiled 2011 equipment.

Grants are subject to an 8.7% haircut for the remainder of this fiscal year due to sequestration.

The fiscal year ends on September 30.

A new haircut percentage will have to be calculated for grants paid after that, assuming sequestration remains in effect.

Any project that received an award letter from Treasury before March 1 will not be affected. Sequestration does not apply to any grant that was an “obligated balance” before sequestration went into effect on March 1. A grant is an obligated balance when Treasury formally notifies a project that a grant in $X amount has been approved for payment.

The 8.7% haircut will apply to grants for which award letters are received during the period March 1 through September 30 this year.

It is unclear whether a haircut will apply to additional payments on grants that were already paid. The Treasury sometimes makes additional payments where developers complain that they were shortchanged.

The Office of Management and Budget said in a report to Congress shortly before sequestration took effect that it is projecting $3.671 billion in grants to be paid in fiscal 2013 from which sequestration requires $187 million in savings. According to the OMB report, the haircut percentage in 2013 would have been only 5.1% if 2013 had been a full year, but a larger haircut is required from remaining 2013 grants since only seven months remain in the fiscal year to achieve the full savings.

Sequestration originally required $109 billion in spending reductions in each of nine years starting in 2013. It was originally scheduled to take effect on January 2, 2013. However, as part of the fiscal cliff deal on January 1, Congress agreed to $24 billion in specific spending cuts and tax increases to pay for a two-month delay to March 1.

That left $85 billion in across-the-board spending cuts for the remainder of 2013. The required spending cuts will be $109 billion for fiscal 2014, but spread over 12 months.

Congress could still decide to suspend sequestration at some point later this year, but the earliest that realistically could occur is late July or August when the government is expected to have reached the limits of its borrowing authority. Congress will have to act by then to increase the federal debt limit. Congress removed some of the political pressure to lift sequestration by giving agencies like the US Department of Agriculture and the Department of Defense more flexibility on how to apply spending cuts within their departments in late March. There had been fears that sequestration would force layoffs of federal meat inspectors.

Some companies facing haircuts in grants have thought about stretching out the application process to push back approval to late summer, by when sequestration may have been lifted. Applications must be filed within 90 days after a project is put in service. There is no formal way to stretch out processing, but the reviewers sometimes send questions and answering them can take time.

NO COSTS WERE “INCURRED” under a construction contract for a large power plant until the plant reached substantial completion, the Internal Revenue Service ruled.

The ruling has implications for renewable energy companies rushing to start construction of new US projects this year to qualify for tax credits.

A utility signed a lump-sum turnkey construction contract with a contractor before 2008 to build a power plant that burns petroleum coke in a circulating fluidized-bed boiler to generate electricity. The utility qualified potentially for a 50% “depreciation bonus” on the project, or the ability to deduct 50% of the cost immediately, but only if it could show that the project was not under construction before 2008. It was a bad fact that the utility had a binding construction contract in place before 2008. The IRS said the fact that the contract price increased as a consequence of a settlement agreement settling conflicting claims that the contractor and utility had against each other, and that other changes were made to reduce the guaranteed output and make small changes in equipment design due to changes in the expected characteristics of the petroleum coke, did not prevent the contract from being considered binding back to the date it was originally signed.

It was also a bad fact that physical work on the project started before 2008.

However, the depreciation bonus rules let one ignore these factors if no more than 10% of the total project cost was “incurred” before 2008. The utility said that under its method of accounting, it does not treat costs as incurred until a project is accepted. The construction contractor retained control over the project and risk of loss until substantial completion. Therefore, the IRS said, no costs were incurred under the construction contract until acceptance of the project by the utility after substantial completion.

The utility had significant construction period interest that was considered incurred before 2008, but it and other pre-2008 costs did not exceed 10% of the total project cost.

The utility failed to claim a depreciation bonus on any of its assets in the year the project went into service. The IRS does not ordinarily rule in cases where a tax return has already been filed, absent special circumstances. The utility appears to have produced a letter from its regulators “requiring” it to claim the bonus. The utility could not just file an amended tax return because the decision to change course on depreciation is considered a change in “method of accounting” requiring IRS permission.

The ruling is Private Letter Ruling 201313012. The IRS made it public in late March.

BATTERIES installed as part of rooftop solar systems qualify for a 30% investment tax credit, but the tax credit is subject to a “75% cliff,” the IRS said.

At least 75% of the electricity stored must come from the solar panels rather than the utility grid, and the percentage investment credit is reduced for the percentage of solar electricity versus other electricity stored in the first 12 months after the battery is put in service. If the solar percentage drops below the percentage in the first 12 months in any of the next four years, then there will be partial recapture of the “unvested” tax credit. The tax credit vests ratably over five years.

Thus, for example, if the solar percentage started at 90% in the first 12 months, then the investment credit would be 90% times 30%, or 27%. If the solar usage dropped to 80% the next year, then the original credit on these numbers would have been 80% times 30%, or 24%, for a 3% difference, but since only 80% of the original credit claimed remains unvested, the battery owner would have to repay 80% times 3% or 2.4% to the US Treasury.

The IRS explained its position in a private ruling to a rooftop solar company. The batteries are on the solar panel side of the inverter.

This is the third private ruling that the IRS has issued about batteries. In two earlier rulings issued to wind companies that planned to install large batteries at wind farms, the agency suggested that the 75% cliff did not apply. One wind company represented that electricity from the grid would account on average for just 3% of the electricity stored in a year, and the other represented that the percentage would be closer to 15%. The solar rooftop company said it could not make any representation about the share of solar electricity that would be stored.

The ruling is Private Letter Ruling 201308005. The IRS made it public in late February.

INDIAN TRIBES can transfer federal tax benefits on projects the tribes own.

The IRS said in a private letter ruling made public in March that a tribe could transfer a 30% investment tax credit on a wind farm the tribe plans to own to a tax equity investor by leasing the project to the investor and electing to pass through the investment credit. This structure is called an “inverted lease.”

According to the ruling, the tax equity investor plans to operate the project and sell electricity back to the tribe or in the open market. The tax equity investor will pass most of the revenue it collects from use of the wind farm to the tribe as rent. It may also pay the tribe a share of the value of the investment credit as additional rent.

The reasoning the IRS used suggests that the tax equity transaction could also have been structured as a sale-leaseback, thereby allowing the tax equity investor to claim both an investment tax credit and depreciation on the project. The tribe would sell the project to the tax equity investor and lease it back. The tax equity investor, as the owner, could claim both benefits. However, the depreciation in that case would be straightline depreciation over 12 years rather than front-loaded or accelerated depreciation over five years. The tax equity investor would also be limited to use of the depreciation as shelter for the rents that the tax equity investor receives from leasing the wind farm to the tribe, unless the lease is structured to stay within guidelines in section 470 of the US tax code.

Normally property owned by a tax-exempt entity or leased to such an entity does not qualify for any investment tax credit. However, the IRS said in the ruling that an Indian tribe is not a tax-exempt entity. Since the tribe is not subject to federal income taxes, the IRS said one never reaches the question whether the tribe is exempted from such taxes. Assets owned by or leased to government entities do not qualify for an investment tax credit either, but the IRS said the investment credit is lost only if the lease is to a federal, state or local government entity. An Indian tribe is considered a sovereign nation.

The ruling is Private Letter Ruling 201310001.

PENSION FUNDS outside the United States may get relief from US taxes.

The United States does not usually tax foreigners on gains from passive investments in US shares, bonds or other assets. Investments in real property are an exception, after the farm lobby persuaded Congress that Japanese investors were driving up the price of family farms and making it harder for children of farmers to buy their own farms. A 1980 law called the Foreign Investment in Real Property Tax Act or FIRPTA requires foreigners to pay tax at ordinary income tax rates on gains from sales of US real property interests, after Congress decided it was too hard to draw a line solely around farmland.

The Obama administration proposed on March 29 that foreign pension funds be exempted from FIRPTA. The idea is to put them on the same footing as US pension funds, which do not pay taxes on gains from passive investments in US real property.

Tax changes like this one can take a long time to get through Congress. The next opportunity for such changes will not come until Congress takes up corporate tax reform. Most lobbyists do not expect action on corporate tax reform before 2014, although the tax-writing committees in both the House and Senate are starting to focus on the details.

PRODUCTION TAX CREDITS for US power plants that generate electricity from wind, geothermal fluid or steam or “closed-loop” biomass will be 2.3¢ a kilowatt hour during 2013.

They remain unchanged at 1.1¢ a kilowatt hour for other biomass, landfill gas and ocean energy projects.

Production tax credits are claimed for 10 years after a project is first put in service on the electricity sold to third parties. Projects must be under construction by December 2013 to qualify. There is no deadline to put them in service. Credits can only be claimed on projects in the United States. It does not matter if the electricity is sold across the border into Mexico or Canada. “Closed-loop” biomass is any plant grown on a so-called electricity farm exclusively for use as fuel in a power plant.

The tax credit amount is adjusted each year for inflation. The IRS calculates the inflation adjustment and announces it each year on or around April 1.

When the tax credits were first enacted in 1992, Congress wrote into the statute that they would start to phase out automatically if electricity prices reach a high enough level that a subsidy is no longer needed. Congress said that level would be reached at 8¢ a kWh. The government looks at the average price at which contracted electricity from the same energy source was sold the year before. Spot sales are ignored. The IRS said 8¢ in 1992 dollars translated into 12.05¢ a kWh in 2012. The credit phases out as the average contracted price moves across a band of the next 3¢ per kWh.

The IRS said the average contracted price at which wind electricity was sold in the United States in 2012 was far below the level at which the credits would phase out. It has not calculated the average sales prices for electricity from the other sources.

The average price at which wind electricity was sold fell last year for the first time in several years. It was 4.53¢ a kWh in 2012, compared to 5.31¢ in 2011, 4.68¢ a kWh in 2010, 4.22¢ in 2009, 4.32¢ in 2008, 3.60¢ in 2007 and 3.29¢ in 2006.

PROPERTY TAXES paid to a US state or local government are usually deductible for federal income tax purposes, but not in every case.

The IRS said in an internal legal memorandum that it made public in March that fire prevention fees assessed against property owners in parts of California where the state is responsible for fighting fires are not deductible as property taxes. The fees are $150 per structure. They must be paid annually.

The IRS said the California legislature viewed the levies as “fees” rather than “property taxes” when it authorized them. Taxes require a two-thirds vote in the legislature. Fees require only a majority vote.

However, even if that were not the case, the IRS said the fees fail three other tests to be considered deductible property taxes.

A property tax is deductible only if it is imposed at a “like rate,” meaning it must be uniformly applied based on an independent variable, like property value or parcel or structure size. This one was a flat rate per structure.

To qualify as a property tax, the levy must apply to all property within the jurisdiction of the tax authority imposing it. The State Board of Equalization collected the fire prevention fee. It has jurisdiction over the entire state, but the fee was limited to a few areas where the state was responsible for fighting fires.

Finally, an amount cannot be deducted as a property tax if it is collected from specific properties in order to pay for a local benefit. An example would be an extra charge on houses in an area to pay for new sidewalks or water pipes.

The IRS said that personal property taxes — in contrast to real property taxes — can also be deducted, but only if they are a percentage of property value. It said there is no such restriction for taxes on real property. The memorandum is ILM 201310029.

NEW SWAP RULES that took effect on April 1 threaten to make some guarantees and security packages in loan transactions unenforceable, according to Andrew Coronios and Monika Szymanski in the Chadbourne New York office. The rules were issued by the US Commodity Futures Trading Commission under the Dodd-Frank Act. The CFTC took the position in a recent no-action letter that “swaps” include guarantees of swaps.

The problem is that every guarantor of swap obligations must be an “eligible contract participant” as defined by the CFTC in order for the guarantee to be enforceable. Lawyers are interpreting this also to affect security agreements and other collateral covering swap obligations. To qualify as an “eligible contract participant,” the entity must have more than $10 million in assets, a net worth of more than $1 million or backing for its obligations through a letter of credit, capital contribution agreement or similar arrangement from an entity with more than $10 million in assets.

Borrowers are often required to hedge interest rate or currency risk, and the loan documents are often written so that the guarantee and security documents cover not only the loan obligations but also the swap obligations. “Under the new rules, if a guarantor or grantor of security is not an eligible contract participant, then the entire guarantee or security document may be unenforceable, even where the direct counterparty to the swap itself is an eligible contract participant,” Coronios and Szymanski said. They said the problem usually comes up where a borrower is an eligible contract participant but its obligations are guaranteed or secured by affiliated companies that may not be.

They recommend taking a number of actions, including not accepting guarantees or security from ineligible entities and adding a “severability clause” that prevents the whole guarantee or security package from being invalidated if only part of it is unenforceable.

NORTH AMERICAN DEVELOPMENT BANK loans are not “subsidized energy financing,” the IRS said.

The North American Development Bank is a bi-lateral development bank that was capitalized by the US and Mexican governments, but that raises money to make loans by issuing debt in the US capital markets. The bank lends long-term debt at fixed rates to help finance projects up to 62 miles north and 186 miles south of the US-Mexican border. It lends to projects that help with potable water supply, wastewater treatment, water conservation, municipal solid waste management, air quality improvement, energy efficiency, renewable energy and public transportation.

A US utility building a wind farm in the US worried that if it borrowed from the bank to finance its project, the IRS might say the loan is “subsidized energy financing.” That would lead to a reduction in the amount of production tax credits that could be claimed on the project.

The IRS said the bank’s loans are not subsidized energy financing because they are not loans under a federal, state or local program a principal purpose of which is to provide subsidized financing for projects that conserve or produce energy. The bank has a broader mandate. Also, there is no subsidy to the borrower. The bank finances its own activity in the capital markets. It borrows at a low rate, without the benefit of a government guarantee, and relends at a higher rate intended to earn a profit.

The IRS addressed the issue in Private Letter Ruling 201308021. The ruling was released to the public in late February.

TAX EQUITY TRANSACTIONS are facing tougher vetting by the IRS.

The agency is losing patience with deals where promoters talk about selling tax credits and structure the transactions so that the tax equity investor has little real economic exposure. A memorandum written by the IRS associate area counsel in Detroit to an agent about a tax equity transaction that is under audit and involves historic tax credits is instructive. The memo is Field Service Advice 20124002F. The agency released it in March.

A 20% tax credit can be claimed on the cost of rehabilitating historic buildings. A real estate developer in the business of renovating historic properties undertook a project. The renovation took at least two years.

The developer arranged for two other entities to be formed. One was a partnership between an affiliated company owned by individuals who also owned the developer and a “fund” of tax equity investors. The partner affiliated with the developer managed the partnership; the fund had no say in management. The other new company formed was a subsidiary of the affiliated company. This subsidiary leased the historic building to the partnership and lent the partnership the money to do the renovations. The partnership hired the developer to do the actual work. The fund of tax equity investors made a small capital contribution to the partnership during construction, but its real capital was not put in until after the renovations were completed. The partnership paid the developer a developer fee and then hired the developer to manage the property for a fixed fee plus a percentage of monthly gross receipts plus an additional supervision fee of a percentage of any capital improvements that have to be undertaken in the future. The partnership is paying the entity that leased it the building fixed rent plus a percentage of the partnership’s operating income, not to exceed 100% of net cash flow.

The capital contributions by the fund were 90¢ per dollar of historic tax credit. The fund was allocated the tax credit and receives preferred cash distributions that are a percentage of its “paid-in” capital contributions. The IRS said debt service on the loan to finance the renovations, the various fees and the lease rents are set at a level that should vacuum up all the remaining cash flow.

Historic tax credits are subject to recapture for five years. The fund has a “put” option to force the partnership or developer to repurchase the fund’s interest at the end of year five for a percentage of the paid-in capital it contributed plus any unpaid preferred cash distributions. The developer has a “call” option to buy out the fund for fair market value, defined in a manner the IRS said will make it close to nil, plus any unpaid preferred cash distributions, after the exercise period for the put expires.

The developer and three of the individuals who own it guaranteed not only the refund if the tax credit was denied or recaptured but also payment of the put price. They also guaranteed all other obligations of the partnership, including excess development and operating costs and the rent owed on the lease.

The developer hired a promoter who was in the business of syndicating historic tax credits to organize the fund. The computer model the syndicator drew up indicated that the fund investors would pay 90¢ per dollar of tax credit and receive an X% priority return plus an additional Y% return on their investment at the end of the tax credit recapture period. A document describing the structure indicated that the transaction would be structured so that the fund would not receive any cash above the priority return.

The IRS said no real partnership was formed. All the benefits and burdens of the project remained with the developer “through a circular flow of contracts,” with the result that nothing in substance changed. The project remained the developer’s project with a side deal to transfer tax credits. The fund did not put any real capital in until after the rehabilitation job was completed.

“The fund never intended to participate in the rehabilitation of the historic property,” the IRS said. “It simply wanted the historic tax credits. If it was not allowed the credits it wanted its money back . . . . [T]he rehabilitation and operations took place as if no transfer to the [partnership] had occurred.”


The Bank of New York borrowed $1.5 billion from Barclays at LIBOR plus 20 basis points in late 2001. The Bank of New York booked the loan through a subsidiary in the Cayman Islands. However, the loan was set up as a transaction run on paper through a trust in the United Kingdom with an elaborate series of agreements a number of which involved circled cash. The main reason for interposing the trust and for some of the arrangements surrounding the trust was to trigger taxes in the United Kingdom on collateral held in a Delaware limited liability company that was a subsidiary of the trust over the term of the loan, which was expected to run through 2006, but to allow the Bank of New York to claim foreign tax credits for them in the United States. Barclays received tax benefits from the arrangement in the United Kingdom and shared half the benefit with the Bank of New York in the form of a reduced interest rate on the loan. The Bank of New York indemnified Barclays against the potential loss of half the UK tax benefits. Absent the tax benefits, the interest rate on the loan would have been LIBOR plus 30 basis points.

KPMG and the Barclays tax department pitched the transaction to the Bank of New York and other banks. They called the structure a “structured trust advantaged repackaged securities” transaction, or STARS for short.

The US Tax Court declined to evaluate the transaction as a whole as a loan with a legitimate business purpose for borrowing at a reduced interest rate, and instead looked at the efforts to generate foreign tax credits for use in the United States as a separate transaction.

That separate transaction had no business purpose, the court said.

Even if the transaction were reviewed as an integrated whole, the court said, the loan was not low cost because the high transaction costs plus the interest paid exceeded the cost of borrowing from Barclays directly.

The court declined to let Bank of New York claim foreign tax credits for any UK taxes it actually paid. It said Congress authorized such credits to neutralize US taxes as a factor in deciding where to conduct real business activities. There was no real foreign activity here, but rather a pre-arranged circular cash flow from collateral held, controlled and managed in the United States. The Bank of New York contributed the $7.86 billion in assets to the trust and the Delaware limited liability company that was a subsidiary of the trust that served as the collateral for the loan and provided cash flow with which to repay the loan.

The case is Bank of New York Mellon Corp. v. Commissioner. The court released its decision in the case in February. B. John Williams, a former IRS chief counsel, argued the case for the bank.

PARTNER GUARANTEES may face greater scrutiny.

A partner sometimes guarantees debts at the partnership level in order to have the debt be added to the “outside basis” the partner has in his partnership interest. IRS rules require that each partner track two measures of what he put into the partnership and what he is allowed to take out: capital account and outside basis. A partner’s outside basis is the equity he invested plus his share of debt at the partnership level. Any debt for which the partner is personally liable is added to that partner’s outside basis. Otherwise the debt is allocated among partners according to complicated rules. By guaranteeing repayment of partnership debt, a partner might give himself a higher outside basis and, therefore, ability to absorb tax benefits.

Jennifer Alexander, an attorney in the office of tax policy at the US Treasury, told an American Bar Association tax section audience in late January that the partner must have a net worth at least equal to the guarantee in order for the guarantee to be respected. In addition, there must be a commercial reason for the guarantee. A guarantee will not be respected if put in place solely for tax reasons.

OPTIONS to purchase partnership interests may have tax consequences, the IRS said.

The agency explained the tax consequences of “noncompensatory” options in final regulations in February. Regulations on “compensatory” options that are given as compensation for providing services will probably not follow until Congress addresses the tax treatment of carried interests that managers hold in private equity funds.

The regulations address options issued directly by the partnership and that give the holder a right to buy an interest in the partnership (or to receive cash or property having an equivalent value). Debt that can be converted into a partnership interest is also considered such an option.

In general, no income tax is triggered when such an option is granted or exercised.

However, someone contributing appreciated or depreciated property for an option will have a gain or loss on the difference in value between the option and his basis in the contributed property.

Letting an option lapse without exercising it will have tax consequences. In that case, the holder of the option can claim a loss for whatever he paid for the option. The partnership must report the original payment for the option as income at that time. (It did not have to be reported as income earlier because it was viewed as part of an “open transaction.”)

The capital accounts of the existing partners may be reset, if the partners choose when the option is granted, so that they add up to the current fair market value of the partnership assets after adjusting for the option. If the option is “in the money” so that it is worth more than the option holder paid for it, then the capital accounts of existing partners would be reduced. If the holder paid more for the option than it is worth, then the capital accounts would be increased. However, once the option is exercised, the capital accounts must be reset to reflect the claim that each partner has over partnership assets should the partnership liquidate. Certain “corrective allocations” will also have to be made when the option is exercised. These are allocations of gross income or loss to help put the capital accounts in the right ratio.

Careful tax counsel will want to keep an eye on options when assessing whether a partnership has terminated for tax purposes. That’s because the IRS may treat an option holder as already a partner if he has rights that are “substantially similar to the rights afforded to a partner.” He has such rights if the option is reasonably certain to be exercised or the option holder possesses partner attributes. Options to purchase for fair market value at time of exercise or that must be exercised within 24 months at a strike price that is at least 110% of the value of the underlying partnership interest are not considered reasonably certain to be exercised. An example of where the option holder already has partner rights might be where he already has some voting rights and cash distributions to him after exercise will give him a share in the economic returns during the period the option was outstanding. A partnership will terminate for tax purposes if 50% of more of the interests in partnership profits and capital are transferred within a 12-month period.

However, the IRS will take the position that an option holder is already a partner only if there is a “strong likelihood” that failure to treat him immediately as a partner will lead to a substantial reduction in the aggregate tax liabilities of the option holder and existing partners.

Options must be retested for whether the option holder has rights substantially similar to a partner on each date an option is issued, transferred or modified. However, only some transfers and modifications trigger retesting.

THE US FOREIGN CORRUPT PRACTICES ACT applies to three Hungarian executives of Magyar Telekom PLC, a federal district court judge in New York ruled in February.

The executives are accused of paying bribes to Macedonian officials to limit a law allowing a competitor into the Macedonian market. American depositary receipts in Magyar Telekom trade on the New York Stock Exchange. The executives were accused by the US Securities and Exchange Commission of misleading US investors when they certified to the company’s auditors that the company’s financial statements were complete and accurate and they were not aware of any violations of law. The certifications were later filed with the SEC.

The executives moved to dismiss the case on grounds that the US courts have no jurisdiction over the alleged crime since it took place in Macedonia by foreign nationals and it occurred more than five years ago. The US judge declined to dismiss. He said the statute of limitations on such crimes does not run while the perpetrators are outside the United States. The case is SEC v. Straub.

The same court said it had no jurisdiction over a German citizen working for Siemens who allegedly encouraged others to bribe Argentine government officials. The particular Siemens employee was not involved himself in paying or authorizing the bribes or in any false filings with the SEC. The second case is SEC v. Sharef.

INITIAL PROPERTY TAX ASSESSMENTS can be capped for wind farms at 33% of installed costs and for solar projects at 12.5% of installed costs, the Tennessee state attorney general said. He said such a cap does not violate a requirement in the state constitution that “[t]he ratio of assessment to value of property in each class or subclass shall be equal and uniform throughout the State.” The caps would not bind assessors when the property is reassessed. They would also be consistent with a finding by the state legislature that wind and solar projects generate only a fraction of the electricity generated by a conventional power plant.

The state legislature is considered imposing the caps to encourage more use of renewable energy. The wind cap is already in effect. The state legislature is considering extending the concept to solar, geothermal and hydrogen energy. The initial caps for geothermal and hydroegen energy would be set by the state department of environment and conservation.

The state attorney general’s views are in Opinion No. 13-19. The opinion is dated March 11, 2013.

In February, the attorney general said in a separate opinion that it would not be constitutional for the state legislature to provide for a four-year phase in of higher property tax assessments when a business makes capital improvements. He said this was similar to an earlier proposal he concluded was unconstitutional to waive property taxes in a depressed part of Jackson, Tennessee in order to encourage new economic development.

It is hard to use property taxes to achieve such goals given the equal assessment clause in the state constitution. The opinion on the fouryear phase in is Opinion No. 13-11 and is dated February 13, 2013.

MINOR MEMOS: The IRS is asserting more frequently on audit that US companies should receive fees from foreign affiliates for whom they guarantee repayment of debts or performance of contracts. The fee income must be reported on US tax returns. Such guarantees may also create complications for any US multinational using an offshore holding company to defer US taxes on foreign earnings until the earnings are repatriated to the United States. The guarantees can trigger a deemed repatriation of earnings or subject income a foreign subsidiary earns from providing offshore services to current US tax as if the services had been performed from the United States . . . . The Congressional Budget Office told a House Science subcommittee in March that 74% of the estimated $16.4 billion that will be spent on energy-related tax incentives in fiscal year 2013 will go to energy efficiency and renewable energy as compared to nuclear energy, oil and gas. However, incentives for oil and gas production are permanent and have been in the US tax code since 1916, while most incentives for renewable energy have either already expired or are scheduled to do so in the next few years . . . . The IRS ruled that a partnership was created between a US company and a foreign affiliate, even though customers dealing with the “partnership” thought they were dealing with the US company. The foreign affiliate took an X% interest in profits from the US company’s branches in a region in exchange for a cash investment equal to the same X% of the branches’ market value. No separate legal entity was created. All property remained held in the name of the US company. The ruling is Private Letter Ruling 201305006. The IRS made it public in February.