Background of Revenue Procedure 2007-65
In 2007, the Internal Revenue Service (IRS) released Revenue Procedure 2007-65, which provides a safe harbor pursuant to which the IRS will respect the allocation to developers of and investors in a wind energy project by a partnership that owns and operates this project (a “Project Company”), of production tax credits arising under Section 45 of the Internal Revenue Code.
The revenue procedure was intended to provide needed certainty to wind developers and investors in light of the IRS’s “no rule” position established in Notice 2006-88 that the IRS will not issue private letter rulings addressing partnership issues arising in connection with the Section 45 production tax credit. In accordance with this intention, as long as the Project Company meets each of the safe harbor requirements of Revenue Procedure 2007-65, the IRS will respect the allocation of claimed credits. Although Revenue Procedure 2007-65 is expressly made applicable only to wind projects, developers and investors often utilize the safe harbor set forth therein to structure investment in other types of renewable energy projects as well.
Revenue Procedure 2007-65 provides that it, like most (if not all) safe harbors established by the IRS, is “not intended to provide substantive rules and are not to be used as audit guidelines.” Thus, while a Project Company that meets all of the requirements of the safe harbor will not be subject to challenge by the IRS, no negative presumption should be attached to a Project Company that fails to satisfy all of the requirements. However, Revenue Procedure 2007-65 contained a statement indicating that the IRS “generally will closely scrutinize a Project Company as a partnership or Investors as partners if a Project Company's partnership agreement does not satisfy each requirement of this revenue procedure.” This statement has led to much confusion and criticism among the participants in the renewable energy industry.
In addition, Revenue Procedure 2007-65 required that any right held by a partner in the Project Company (or any related person) to acquire an interest in the Project Company (or in the underlying wind project) cannot be exercisable at a price less than the fair market value of such interest, determined at the time of exercise (emphasis added). This language was also criticized as unnecessarily restrictive by numerous industry participants, who generally asserted that a fair market value price negotiated by unrelated parties at arm’s length should be sufficient, regardless of when that price is determined.
The IRS recently issued Announcement 2009-69, which favorably amends Revenue Procedure 2007-65 to address the criticisms discussed above. Specifically, the IRS eliminated the sentence in the revenue procedure that provided that the failure to satisfy the safe harbor requirements would subject the Project Company to close scrutiny, thus confirming that such failure will not cause any negative inference to be drawn.
The IRS also expanded the safe harbor relating to the exercise of a right to acquire an interest in the Project Company (or in the underlying project). Such right will satisfy the expanded safe harbor if (1) it is negotiated for valid non-tax business reasons at arm’s length by parties with material adverse interests, and (2) the purchase price for the interest is either a price that is not less than the fair market value of the interest determined at the time of exercise or, if the purchase price is determined prior to exercise, a price that the parties reasonably believe, based on all facts and circumstances at the time the price is determined, will not be less than the fair market value of the interest at the time the right may be exercised.
Final Thoughts The safe harbor requirements of Revenue Procedure 2007-65, if met, provide much needed certainty to developers of and investors in wind, as they ensure that the IRS will not challenge allocations made by the Project Company of Section 45 production tax credits. Moreover, developers of and investors in other renewable energy projects may also take some comfort in the recent announcement as they too often rely on Revenue Procedure 2007-65 when structuring their projects. The revisions to this revenue procedure made by Announcement 2009-69 clarify that the failure to meet all of the safe harbor requirements will not subject the Project Company to close scrutiny and will make it easier to meet these requirements by relaxing the fair market value “determined at the time of exercise” rule. As a result, Announcement 2009-69 represents a significant and favorable development to the renewable industry.