In Alta Wind I Owner Lessor C, and Alta Wind I Owner Lessor D, et al. v. United States, Nos. 13-402T, 13-917T, 13-935T, 13-972T, 14-47T, 14-93T, 14-174T, 14-175T (October 31, 2016) (Alta Wind) the U.S. Court of Federal Claims (Claims Court or Court) awarded owners of six wind farms (Alta Wind Owners or Owners) the full energy grant claimed under Section 1603 of the American Recovery and Reinvestment Tax Act of 2009 (Section 1603). The Court found that the owners properly claimed a grant based on the amount paid to purchase the wind farm (with minor reductions for ineligible property) and that the government's use of a different valuation approach to reduce the basis of the property was not supported by section 1603 or the Internal Revenue Code (Code).

Facts

Alta Wind Owners acquired six wind farms in Southern California either by outright sale (one wind farm) or in sale-leaseback transactions (five wind farms). The wind farms were acquired during the period 2010-2012 and were placed in service over the same period. Owners applied to Treasury for an energy grant under Section 1603 in an amount equal to thirty percent of the amount paid for eligible property (i.e., the total purchase price paid for the wind farms reduced by amounts allocable to ineligible property such as land and transmission assets). Treasury paid Owners a reduced amount equal to thirty percent of the construction and development costs incurred by the developer of the wind farms. The aggregate difference between the amount claimed by Owners and the amount paid by Treasury was almost $207 million ($206,833,364).

Law and applicable guidance

Section 1603 is a provision outside the Code under which the Department of the Treasury pays a cash grant to the owners of qualified renewable energy property that elect the grant as an alternative to the investment tax credit under Code Section 48 (ITC) or the production tax credit under Code Section 45 (PTC). Qualifying renewable energy property includes qualified property (within the meaning of Section 48(a)(5)(D)) that is part of a qualified facility (within the meaning of Section 45).

Section 45 specifies qualified facilities include a facility using wind to produce electricity. Section 48(a)(d)(5) further states that qualified property includes (i) tangible personal property and (ii) other tangible property (not including a building or its structural components) used as an integral part of the qualified facility. The Internal Revenue Service has not issued guidance defining qualified property for purposes of Section 48. However, the Treasury Department guidance under Section 1603 (the Section 1603 Guidance)¹ provides that qualified property includes only "tangible property that is an integral part of a qualified facility if the property is used directly in the qualified facility and is essential to the completeness of the activity performed in that facility." The guidance excludes from qualified property "electrical transmission equipment, such as transmission lines and towers, or any equipment beyond the electrical transmission stage, such as transformers and distribution lines."

Section 1603 states that the amount of the payment is equal to the applicable percentage of basis of the qualified property (30% of basis in the case of qualified property that is part of a wind facility). For this purpose, basis has the same meaning as when used in Section 48. Thus, the basis for purposes of Section 1603 is the same as the basis for purposes of the Federal income tax. Under Section 1012(a) of the Code, "[t]he basis of property shall be the cost of such property."

Computation of basis

The Court noted that the basis in purchased (as opposed to self-constructed) wind farms generally would be the facility's purchase price, as this is the cost of the facility to the buyer. The Court recognized that there are exceptions to this general rule, several of which were raised by the government.

The Government argued that the purchase price should be allocated under Section 1060 of the Code, with the result that part of the purchase price would be allocated to intangible assets (such as goodwill or going concern value) that do not qualify for Section 1603 grants. The applicability of Section 1060 is limited to the transfer of assets that constitute a trade or business (Section 1060(c)(1)). The regulations state that assets constitute a trade or business if their "character is such that goodwill or going concern value could under any circumstances attach to [the assets]." The Court concluded, essentially because the wind farms were not operational at the time of the sale, that neither goodwill nor going concern value could attach to the assets and, therefore, Section 1060 did not apply. Instead, the Court found that the completed wind farms had turn-key value (i.e., the value a facility has when it is ready for immediate use after purchase) in excess of the costs incurred in the development and construction of the facility and that this value was properly allocable to the wind farms' tangible property.

The government also argued that the purchase price should not be determinative of basis because (i) the purchase transactions were not conducted at arm's length by two economically self-interested parties and (ii) the transactions were based on peculiar circumstances which influenced the purchaser to agree to a price in excess of the property's fair market value. The Court dismissed the first argument, concluding that "[t]he weight of the evidence demonstrates that all of the … transactions were negotiated by sophisticated parties at arm's length [who] extensively negotiated to achieve the best possible purchase price. The peculiar circumstances claimed by the government were the use of sale-leaseback transactions, side agreements between the parties, and agreements by the seller to indemnify the purchasers in the event they did not receive the full Section 1603 grant claimed based on the purchase-price basis. The Court dismissed the government's sale-leaseback argument in large part because the purchase price paid in the sale-leaseback transactions was essentially the same on a per-kilowatt basis as the purchase price in three outright-purchase transactions for wind farms in the same development (two of the outright-purchase transactions were not involved in the litigation). As to the side agreements and Section 1603 indemnity, the Court found no evidence that the side agreements significantly inflated the purchase price and noted that the Section 1603 indemnity was similar to tax indemnities commonly found in commercial transactions. The Court concluded that the method used to allocate the purchase price between qualified property and property ineligible for the credit was reasonable and did not inflate the basis of the qualified property. Finally, and perhaps most importantly, the Court rejected the government's argument that part of the purchase price should be allocated to power purchase agreements (PPAs), which the government maintained are separate items of intangible property. The Court concluded that the PPAs, which were tied to specific facilities and were not transferable or assignable, could not be viewed as assets separate from the underlying facilities. (For a discussion of Internal Revenue Service private letter rulings addressing this issue see Tax Alert 2012-2064.)

It should be noted that the government was unable to present its full case. The government sought to introduce expert testimony in the areas of economics, finance, and valuation, but the court excluded the testimony because the government's sole expert witness failed to disclose his complete publication record.

LCM Energy Solutions

In a second case, released the week before the Alta Wind decision, the Claims Court upheld Treasury's reduction of the Section 1603 grant claimed with respect to solar panels. In LCM Energy Solutions v. United States, No. 12-321C (October 27, 2016) (LCM Energy Solutions) the solar panels were transferred by the installer, a corporation, to LCM Energy Solutions (LCM), a separate entity owned by the shareholders of the installer and then leased by LCM to the end users. The opinion did not describe the legal form of LCM or the terms of the transfer from the installer to the LCM, but concluded that the cost basis of the solar panels for purposes of section 1603 was equal to the installation costs incurred by the installer plus a twenty-percent profit. The Court did not explain why it was appropriate to include a profit margin in basis other than to note that this was the methodology used by Treasury in awarding the reduced grants to LCM and to suggest that the resulting basis approximated the fair market value of the installed solar panels.

Implications

The most direct implication of the holding in Alta Wind is that purchase price can be used, absent special circumstances, to determine basis for purposes of Section 1603. Of particular importance is the Court's rejection of the government argument that part of the purchase price should be allocated to PPAs and treated as an amount paid for intangible assets. Since Section 1603 has expired for property on which construction began after December 31, 2011, the principal implications of the opinion going forward will be with respect to the investment tax credit under Section 48 of the Code. That Section provides a nonrefundable investment tax credit (ITC) determined by reference to the basis of energy property. We note that the IRS did not administer the Section 1603 program and that the IRS may not consider itself bound by Section 1603 program guidance issued by the Treasury Department's Office of the Fiscal Secretary. In this case, however, Alta Wind relies entirely on income tax precedents in determining basis for purposes of Section 1603 and was decided by a court that also has jurisdiction over refund claims under Section 48. Accordingly, the Alta Wind analysis should be equally applicable in determining the amount of the investment tax credit under Section 48.

ITC claimants should be aware that the Tax Court has not ruled on the issues presented in Alta Wind. Thus, in pursuing their claims, they should consider whether a refund suit in the Court of Claims might be preferable to a Tax Court proceeding, even though a refund suit (unlike a Tax Court proceeding) would require advance payment of the tax that would be offset by the ITC.

Caution is in order, particularly in sale-leaseback transactions. First, it should be noted that the Court's opinion was quite dependent on the facts and the Alta Wind Owners had very good facts. Specifically, in addition to sale-leaseback transactions, the Owners engaged in a number of outright sales transactions at a comparable price on a per-kilowatt basis.

Caution is also in order because the government may not have been able to present its best case because of the exclusion of its expert witness testimony. Finally, because of the large amount at stake in this case and potentially at stake in other cases under Section 1603 and Section 48, it is quite likely that the government will appeal the case to the U.S. Court of Appeals for the Federal Circuit.

Because key facts and elements of analysis are omitted, it is difficult to draw conclusions regarding the implications of LCM Energy Solutions. The opinion may suggest, however, that when energy property is sold by a developer to the person who will place the property in service, a markup of twenty-percent or less will respected.²

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ENDNOTES

¹ U.S. Treasury Department, Payments for Specified Energy Property in Lieu of Tax Credits under the American Recovery and Reinvestment Act of 2009, Program Guidance (rev. April 2011)

² In Utilicorp United, Inc. & Subsidiaries v. C.I.R., T.C. Memo. 1997-47, which involved the purchase from a developer of a hydroelectric power plant, the Tax Court similarly accepted a 20-percent profit markup as appropriate.