Credits to Keith Martin, Eli Katz, Ken Hansen and I, at Chadbourne & Parke, analyzed the stimulus bill that President Obama signed today. They released the following short discussion on its implications to the renewable power world.
Overveiw of Alternative Lease Structures for Renewables
Choosing an investment credit will open the door to two forms of lease transactions that cannot be used in projects on which production tax credits are claimed. They are sale-leasebacks and inverted passthrough leases.
In a sale-leaseback, the developer sells the project to a tax equity investor and leases it back. The developer shares in the tax benefits in the form of a reduced rent to use the project. The lease cannot run longer than 80% of the expected life and value of the project. If the developer wants to continue using the project after the lease ends, then it must either negotiate an extension at then current market rent or buy the project. It can have an option to buy back the project for a fixed price negotiated in advance, but the price will be the expected value of the entire project -- unlike in a partnership flip where the developer gets back 95% of the project automatically and has to pay the market value of only a 5% interest to recover the balance of the project.
In an inverted passthrough lease, the developer leases the project to a tax equity investor. The tax equity investor sells the electricity and pays most of the electricity revenue to the developer in the form of rent for use of the project. The developer elects to pass through the investment credit to the tax equity investor as lessee. The tax equity investor claims the investment credit and deductions for rent that may come close to mirroring the depreciation the investor would have had had it owned the project. The developer keeps the depreciation and uses it to shelter the rents from taxes.
There has been a lot of interest among solar developers in inverted leases. The lease term in such transactions runs anywhere from six to 15 years. At the end of the lease, the developer takes back the project without having to pay anything for it. The market has already pushed the structure to an aggressive form that presents significant tax risk. There are other forms that are more conservative.
Projects on which investment credits are claimed face strict deadlines for when a tax equity transaction must be put in place.
An investment credit can be transferred in a partnership flip transaction or a sale-leaseback or inverted lease. If it is transferred in a partnership flip or inverted lease, then the tax equity must be in the partnership before the project is placed in service. A sale-leaseback must be put in place within three months after the project is placed in service.
There is no similar deadline for partnership flip transactions involving production tax credits. They can close whenever a tax equity investor is found. The investor cannot share in production tax credits that run before closing on the flip partnership, but it can pick up with credits for the remainder of the 10 years.
The option to claim an investment credit may allow wind, geothermal, biomass and marine energy companies the ability to tap a few additional tax equity investors who will invest in lease structures but not partnership flips. Some bank leasing companies fall into that category. Solar and fuel cell companies already had access to them. From their standpoint, this will introduce more competition for what were already scarce dollars in the market for lease equity.
The main advantage of a sale-leaseback is it provides 100% financing. The tax equity investor must pay the full market value for the project. Another advantage is that all of the tax benefits are transferred in the structure. Complicated tax accounting rules make it difficult in many partnership flip transactions to transfer even 99% of the tax benefits. Virtually all flip deals done in the past year have faced "absorption" issues with tax benefits.
The downside of doing a sale-leaseback versus a partnership flip is it costs more for the developer to get the project back. After the lease ends, the developer can only continue using the project by purchasing it from the investor. There is also a different risk allocation in leases compared to partnership flips. The developer may be required to give the investor a broader indemnity against loss of tax benefits in a lease.
There may be room for argument about the basis on which the 30% investment credit should be calculated in wind farms and biomass and marine energy projects. The stimulus bill allows the 30% credit to be calculated on the cost the "facility" as defined in the production tax credit statute. Not all equipment at such a project is considered part of the "facility."
For example, each turbine, pad and tower at a wind farm is considered a separate "facility." The "statement of the managers" that accompanied the final stimulus bill suggested that Congress intended wind companies will be able to claim the credit on the same property that qualifies for depreciation over five years. That would include the SCADA system for controlling operation of the turbines and the collection system for collecting the electricity before it is fed through the bus bar on its way to the grid.
One downside with claiming an investment credit is it will make any tax equity investment in the project more illiquid. The investment credit will be recaptured in part if a project, or the interest an investor holds in a project, is sold within five years. Investment credits "vest" at the rate of 20% a year. Thus, if an investor sells his entire interest 15 months after a project is put in service, then 80% of the credit the investor claimed will be recaptured. An investor in a partnership can reduce his interest by up to a third without suffering recapture, but no more than that.
The stimulus bill drops a rule that until now has barred the investment credit from being claimed on a project to the extent the project benefited from tax-exempt financing or subsidized energy financing. The rule is eliminated for projects placed in service after 2008. This may give some developers a reason to choose investment credits over production tax credits. Production tax credits will continue to suffer a haircut of up to 50% to the extent a project benefits from any grant, tax-exempt financing, subsidized energy financing or other federal tax credits.
Any such transaction using a partnership flip or inverted lease structure must fund before the project is placed in service. Any sale-leaseback of the project -- including a sale-leaseback where the lessor chooses to leave the grant with the developer-lessee -- must be done within three months after the project is placed in service. The problem with waiting longer is a grant paid to the developer will be recaptured. Except for a short window around when the project is placed in service, a developer must hold any project on which a grant is paid for at least five years after it goes into service.
Only 85% of the cost of any project on which a grant is paid can be depreciated. However, in cases where a project is leased and the parties choose to leave the grant with the lessee, the lessor can depreciate 100% of the project cost, but the lessee must report half the grant as income. The income would have to be reported ratably over the period the project is depreciated.
Developers of large solar thermal, geothermal and biomass projects that take more than a year to construct may need a commitment letter from the Treasury in order to secure construction financing.
Companies that renegotiate debt risk having to report "cancellation of debt" income. Such income might be triggered in various situations. One example is where a company (or its affiliate) buys back its own debt that is trading at a discount in the public market. Other examples are where a lender agrees to convert a loan into an equity interest in a project or where the debt terms are renegotiated, but in a manner that is considered a "significant modification" of the original loan. In the last case, the parties are treated as if they swapped the old debt for a new one. Cancellation of debt income might have to be reported if the new debt is considered an obligation to repay less money than before because the original debt instrument has lost market value.
The bill will let any income triggered by restructuring debt during 2009 and 2010 be reported ratably over the period 2014 through 2019.