Tax changes close equity avenue -- Financing uncertainty

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The Canadian government's surprise announcement that it plans to tax publicly traded income trusts and limited partnerships at the same rate as corporations could put a chill on use of an advantageous wind farm financing model. Investors in wind developments structured as "flow-through limited partnerships" will now need a new exit strategy.

In recent years, a number of companies have created flow-through LPs to take advantage of the government's Canadian Renewable and Conservation Expense (CRCE) program. CRCE allows developers to write off certain expenses, including the installation of test turbines that can make up as much as 20% of a project's nameplate rating. In a flow-through LP, the write-offs are allocated to investors who claim them on their income tax.

While the proposed new rules will not change the ability of developers to raise capital from the investing public using flow-through LPs, says Darin Renton of the Toronto law firm Stikeman Elliott LLP, they do affect what happens once the test phase is complete. "I think the issue and the largest impact on wind farm development is going to be the liquidity event, the exit event. What are you going to do with that partnership once the CRCE phase is done?"

Holdings in flow-through LPs typically do not trade on any secondary markets. "Once you've got the tax benefit, your Aunt Sally is not going to want to buy your illiquid LP unit from you," explains Renton. So to provide liquidity for investors, the partnerships have followed one of two strategies. The first is to list on a stock exchange. "Listing may be a problem because then the LP could be subject to income tax under the proposed rules. The second exit was to sell to an income trust, and those are clearly caught by the new rules." Renton was involved in AirSource Power Fund I LP's offering of units that raised C$65 million to help finance the 99 MW St Leon wind farm in Manitoba.


By early December, the government had still not tabled legislation outlining how its new tax plan would be carried out. At the same time there is a moratorium on expansion of existing trusts. The situation is leading to significant uncertainty in the sector, says Renton. "I think large public flow-through offerings of wind farms may be harder to launch until we figure out who you can sell to."

Toronto-based Ventus Energy, however, has not let the changes stop its offering of units in the Ventus Energy West Cape Windpower LP, which is looking to raise C$25-55 million to finance the CRCE phase of its 99 MW West Cape project in Prince Edward Island. Ventus CEO John Douglas sees other avenues to provide liquidity to unit holders. "I think the more likely buyer is a large international energy company focused on wind and looking for an entry point into the Canadian market," he says.

In financing West Cape, Ventus is taking a road not travelled in Canada. Most wind power in the country is developed through government or utility sponsored requests for proposals offering long term power purchase agreements (PPAs). While Ventus has a 20 year contract with the City of Summerside for 9 MW, most of West Cape's output will be sold into the north-eastern US at prevailing market rates on the New England Power Pool (NEPOOL). Ventus has also received approval to market its renewable energy credits (RECs) in the Massachusetts REC market.

Power pool preference

"We deliberately didn't want to sign a long term PPA that hands your green attribute value over to a utility," Douglas explains. "In our effort the maximize cash flow and revenues, we like the NEPOOL. It gives us access to additional revenue streams that we otherwise wouldn't have here in Canada, namely the RECs, which are trading for almost the same price as the electricity. And a third revenue stream that we can realise are capacity payments for simply being connected."

Douglas believes the strategy will make the project attractive to potential buyers. Gas-fired generation makes up about 40% of NEPOOL's generation and sets the market price 87% of the time. "I think people, the people we are talking to anyway, want that exposure. They think, like us, that prices are going higher."

West Cape's "test turbine" CRCE phase, made up of 11 Vestas 1.8 MW turbines, is expected to come online by the second quarter of 2007. The remaining 44 turbines are to be operating by the third quarter of 2008.

Finance Minster Jim Flaherty announced the new tax plan in an attempt to stem a growing trend of corporations converting to income trusts. In 2006 alone, the market value of companies making the conversion was approaching C$70 billion. Income trusts pay little or no corporate tax, instead shovelling out the bulk of earnings to investors, who are taxed individually. "Left unchecked, such corporate decisions would result in billions of dollars in less revenue for the federal government to invest in the priorities of Canadians," Flaherty said.

The new measures will come into effect in 2011 for existing trusts and 2007 for those that begin trading after October 31. The income trust sector plunged in the wake of the announcement, losing about C$20 billion of its market value on the Toronto Stock Exchange the day following the announcement.

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