On October 19, 2007, the IRS released Revenue Procedure 2007-65, which establishes safe harbor rules under which the IRS will respect the allocation of Section 45 wind energy production tax credits among the partners of a partnership that owns a qualified wind energy facility.
Section 45 of the Internal Revenue Code provides for a renewable electricity production credit in an amount equal to the product of 1.5 cents multiplied by the kilowatt hours of electricity produced by the taxpayer from “qualified energy resources” at a “qualified facility” during the 10-year period beginning on the date the facility is placed in service. “Qualified energy resources” include wind. In the case of a wind facility, the Section 45 credit is available for any facility originally placed in service before January 1, 2009.1
The new safe harbor applies to any partnership or limited liability company (“Project Company”) between a project developer (“Developer”) and one or more investors (“Investors”) with the Project Company owning and operating the project containing the qualified facility (“Wind Farm.”) The safe harbor will apply only if the Developer, Investors and Project Company satisfy all of the requirements set forth in the Revenue Procedure. Furthermore, the IRS has stated that it will closely scrutinize a Project Company and its Investors if the Project Company’s partnership agreement does not satisfy all of the requirements of the Revenue Procedure.
The safe harbor contains specific requirements for the following:
- Partners’ Minimum Partnership Interest. There are separate requirements for the minimum interest in each material item of partnership income, gain, loss, deduction and credit for the Developer (1%) and an Investor (5%).
- Investor’s Minimum Unconditional Investment. An Investor must make and maintain a minimum unconditional investment in the Project Company of 20% of the sum of the fixed capital contribution plus reasonably anticipated contingent capital contributions required to be contributed by the Investor under the partnership agreement.
- Contingent Consideration. At least 75% of the sum of the fixed capital contributions plus reasonably anticipated contingent capital contributions must be fixed and determinable obligations that are not contingent in amount or certainty of payment.
- Purchase Rights. Neither the Developer, the Investor nor any related parties may have a right to purchase the Wind Farm or an interest in the Project Company at a price less than its then fair market value. In addition, the Developer may not have a right to purchase the Wind Farm or an interest in the Project Company earlier than 5 years after the facility is first placed in service.
- Sale Rights. The Project Company may not have a right to cause any party to purchase the Wind Farm (other than the right to purchase electricity) from the Project Company. An Investor may not have a right to cause any party to purchase its partnership interest in the Project Company.
- Guarantees and Loans. The safe harbor prohibits any person from guaranteeing or otherwise insuring the Investor the right to any allocation of the credit under Section 45. The Developer, the turbine supplier or any power purchaser may not provide a guarantee that the wind resource will be available at a certain level.
- Allocation of the Section 45 credit among the partners. The Section 45 credit must be allocated in accordance with Treasury Regulations section 1.704-1(b)(4)(ii), which sets forth the rule for allocations of credits among partners.
- Separate Activity for Purposes of the Passive Activity Loss Rules. For purposes of the passive activity loss rules, each Wind Farm will be treated as a separate activity. Thus, only investors that are not subject to the passive activity loss rules (such as C corporations,) and not individuals, will be able to offset non-project income with Section 45 credits.
The Revenue Procedure also contains an example of the application of the safe harbor rules as well as an acceptable allocation of the Section 45 credit. In the example, the Investor does not make its investment in the Project Company until construction of the Project is substantially complete. During Periods 1 and 2 (each of which continues until certain benchmarks or dates are reached) , the Investor is allocated 99% and the Developer is allocated 1% of the Project Company’s gross income or loss and Section 45 credits. During Period 1, 100% of the cash is allocated to the Developer, and during Period 2, 100% of the cash is allocated to the Investor. During Period 3 (which will not occur until after the 10-year period that the Section 45 credit is available,) the Developer will have the option to purchase the Investor’s interest in the Project Company for its then-appraised fair market value. If the Developer does not exercise this option, then during Period 3 the Investor is allocated 5% and the Developer is allocated 95% of the Project Company’s cash, gross income or loss and Section 45 credits.