Under such flip deals, the equity investor is allocated most of the project's PTCs and cash proceeds until a targeted return is reached, at which point the equity interest in the project flips down to a single digit percentage. The IRS has now laid out a series of requirements these deals must meet to avoid being questioned by the tax department. Those that stray outside these bounds will be closely scrutinised, the IRS says.
Keith Martin, a project finance specialist with the law firm Chadbourne & Parke, says the guidelines are good news for the wind industry. "These structures are somewhat aggressive and the IRS has essentially blessed them with this safe harbour," he says. At the same time, developers and investors can go outside the guidelines if they are prepared to take the risk of greater IRS scrutiny. "The safe harbour is not a statement of substantive law. It is just a line drawing exercise by the government. The government is telling the industry that people who stray outside the safe harbour will be asked questions on audit. If you stay in, then no questions."
Questions are already being asked, about how long developers and investors will try to stay within the safe harbour and how they can "break out" and still meet with IRS approval, says Martin. The interest in creating more aggressive deal structures comes down to competitiveness, he adds. "Developers are looking for the cheapest cost money and the equity investors are trying to win deals. There is a fair amount of competition still to win these transactions."
It was the industry's increasing aggressiveness that led the IRS to issue the guidelines in the first place. In November 2005 it issued three private letter rulings that signalled it accepted the partnership flip structure. "Then in February 2006 it received two other requests that pushed the envelope on the structure. As happens so often in these industries, people are never satisfied with where things are at the moment," says Martin. "The IRS was not comfortable with the requests so it said hold on, let us organise our thoughts before we issue any other rulings." With the new guidelines now in place, the agency says it will no longer issue any private rulings on individual issues.
In one of the February 2006 cases, the project partners wanted an advance ruling on whether a developer could guarantee the equity investor a minimum return. In the second, the equity investor wanted to buy into the deal over time as it received its PTCs.
The tax department's concern, says Martin, is that equity investors have a true ownership stake in projects and are not just acting as lenders for a fixed return. "They also wanted to rule out cases where purported equity investors are just bare purchasers of tax benefits. Under US tax law you cannot buy tax benefits. Trafficking in them is not allowed. The only people who are entitled to claim tax subsidies are people who are part owners of a project."