On June 20, 2023, the Court of Federal Claims denied summary judgment to the taxpayer in Alta Wind I Owner-Lessor C, et al. v. United States (“Alta Wind (2023)“),1 the latest episode in an ongoing multifaceted dispute over the calculation of the Section 1603 grant. While the Section 1603 grant expired over a decade ago, the jurisprudence around this program—most notably the Alta Wind cases—can nonetheless have implications for the taxpayers taking the investment tax credit (“ITC”).
The Section 1603 grant arose not from the Internal Revenue Code, but from a separate Treasury-administered federal program that was created under Section 1603 of the American Recovery and Reinvestment Tax Act of 2009. Under this program, the Treasury made payments in lieu of ITCs to eligible applicants for specified energy property. Similar to the ITC, the Section 1603 grant in most cases was calculated as 30% of the basis of the relevant property; in the case of wind farms, for example, only property that was an integral part of the wind facility was taken into account for purposes of determining the Section 1603 grant.
Background
The Alta Wind saga began in 2010-2012, when various taxpayers acquired six wind farms from Terra-Gen, five of them pursuant to sale-leaseback transactions. Each of the Alta wind farms was the seller of electricity in a 24-year power purchase agreement (“PPA”), along with other intangibles such as transmission rights. In calculating the Section 1603 grant, the IRS allocated a certain amount of the project basis to the value of such intangibles under the residual method of Section 1060, i.e., according to a “waterfall” of asset classes, including tangible property (Class V), Section 197 intangibles (Class VII) and goodwill and going concern value (Class VII); the taxpayer argued, inter alia, that no goodwill or going concern value could have existed at the time of transfer because the facilities were not yet operational and the residual method, under the Section 1060 regulations, applied only to an active trade or business or to an asset group to which “goodwill or going concern value could under any circumstances attach.” The taxpayer also asserted that the PPAs, rather than being customer-based Section 197 intangibles, related only to their specific wind farms, were not transferable or assignable, and accordingly could not be viewed as separate assets from their wind farms.
The Court of Federal Claims sided with the taxpayer in a 2016 decision (“Alta Wind (2016)“),2 but the Federal Circuit disagreed and vacated the decision on appeal in 2018 (“Alta Wind (2018)“),3 stating that (1) the wind farms were nearly complete and it was obvious that goodwill could attach to the wind farms immediately after the acquisition by the taxpayers and (2) customer relationships, like goodwill itself, could exist as separate intangibles even if they were associated with a particular facility. The case was then remanded to the Court of Federal Claims to determine the proper allocation of the purchase price pursuant to the residual method in Section 1060.
Recursive Section 1603 Grant Calculations and Premiums as Tangible Property
The Court of Federal Claims in Alta Wind (2023) rejected three taxpayer arguments relating to the calculation of the Section 1603 grant.
First, the taxpayer argued that a Section 1603 grant should be included in the taxpayer’s basis in the project for purpose of calculating the Section 1603 grant itself, in large part because Section 48(d)(3)(B) states that the grant “shall be taken into account” in determining property basis. The court agreed with the IRS, concluding after a detailed statutory interpretation discussion that Section 48(d)(3)(B) only governs the basis reduction of energy property under Section 50(c) and not the calculation of the Section 1603 grant itself. The court also pointed out that reincorporating the grant into basis to then calculate (and “inflate”) the same grant would require “recursive calculations, the stopping point of which can only be arbitrary.”
Second, the taxpayer argued that the grant should be included as grant-eligible property for purposes of calculating the amount of the Section 1603 grant, on the ground that “cash flows stemming from ownership of property are components of the property itself.” While the government successfully argued that this would create a circularity in the calculation of the grant, the court also focused on the fact that the grant was not a tangible asset and so could not be grant-eligible property in rejecting the taxpayer’s argument.
Third, the taxpayer argued that any incremental consideration associated with a premium for the anticipated value of the Section 1603 grant should be part of the eligible basis, on the ground that such premium constituted part of the eligible tangible property in the project. The court rejected this argument as well, dismissing several taxpayer-cited precedents as being inapposite; based on the court’s questions at oral argument, its conclusion was likely based on the lack of explicit support for this approach in the residual method depicted in the Section 338 and Section 1060 regulations. The court also came to a similar conclusion with respect to certain indemnities associated with the cash grants.
Practical Implications for the Renewables Industry
Alta Wind (2023) raises provocative questions. Why are recursive calculations apparently corrosive to the tax system when the same calculations are regularly used to price depreciation into asset acquisitions? Why can’t a Section 1603 grant be viewed as unit-contingent with respect to the wind farm, under the logic of Alta Wind (2016)? If the Section 1603 grant is indeed a separate asset, is it a capital or ordinary asset, and how would you amortize it?
Although the decision appears highly taxpayer-unfriendly, its real-world effect is somewhat murky. First, there is a strong argument that Alta Wind (2023) has limited or no applicability beyond government grants such as the Section 1603 grant. A government grant, once a project has been placed in service and administrative requirements have been met, is a relatively sure source of income. A tax credit, by contrast, generally can only result in added value under narrow conditions: the taxpayer must have taxable income that the credit can offset, limitations such as the alternative minimum tax and the passive loss rules may limit a taxpayer’s ability to use the credit, and the taxpayer must file a return in order to receive such credit (an undertaking that many foreign taxpayers, for example, seek to avoid). Even post-IRA, only tax-exempt, tribal or governmental taxpayers are automatically eligible for direct pay for investment-based credits; while ordinary taxpayers can transfer credits, the price they will receive for these credits is determined by the market and subject to the creditworthiness of the credit buyer. It is thus inappropriate to view an anticipated ITC associated with a not-yet-COD project as a Section 1060 asset, unlike a government grant that is a separate government entitlement, even if the project is very close to completion. Requiring anticipated tax benefits to be included in Section 1060 calculations would create a massive, perhaps unprecedented, change in how the market currently treats such calculations, both inside and outside of the renewables industry. Conversely, while the court’s denigration of recursive grant calculations seems quaint, there definitely is not a widespread trend of expecting the IRS to follow such recursive calculations for purposes of ITC calculation.
The court provides no clear guidelines for how the IRS might identify a “premium” for an anticipated grant (or, assuming there even is an analogy, tax credit). While traditional tax equity financings obviously take tax credits into account, the financial modeling of contributions, distributions and allocations (or, in the case of a sale-leaseback, rent payments) does not reveal an easily discernible “premium” being paid by the tax equity investor; the main way in which a premium might be clearly deduced is through the initial agreed-upon value of the project when the tax equity financing occurs, which in larger projects is generally supported by a third-party valuation. In most cases, however, the third-party valuation does not incorporate any tax credits at all. Typically, the valuator produces two potential values—one based on the cost of constructing the project, which is unaffected by anticipated tax credits (the “cost approach”) and one based on the discounted cash flows produced by the project, including anticipated tax credits (the “income approach”)—and chooses the lower number to be the FMV. Even in the relatively rare cases where a valuator chooses to average or relatively weight the two amounts, there is a good argument that the valuator’s final appraisal of a tangible asset should be respected by the IRS as such, even if it takes anticipated tax credits into account. Nonetheless, some taxpayers might understandably scrutinize such a valuation approach in light of Alta Wind (2023). In addition, while Alta Wind (2023) does not cast any doubt on the validity of developer markups or developer profit arrangements, taxpayers might be more wary about any attempts by valuators to justify unusually high developer margins by citing the magnitude of the ITC.
Alta Wind (2023) is merely the court’s denial of partial summary judgment requested by the taxpayer; it is not impossible that a more thorough discussion of the case, with more factual context to illustrate the court’s views, might follow in a future decision. As the Alta Wind story continues, taxpayers—and third-party valuators—should follow closely.