Tax News
FAA 20161101F – A tax equity deal gone wrong
March 18, 2016
Administrative Actions
For readers that do not specialize in this area, tax equity transactions are prevalent in the energy sector and other sectors that offer tax credits or other incentives to stimulate particular activities (for example, historic rehabilitation in the case of Historic Boardwalk).  The main parties to the transaction are the tax equity investor and the developer of the project. Typically the deal will be structured as a partnership flip whereby the investor receives 99% of the tax benefits until a flip point (based on IRR or fixed date) and a 5% of profit/loss thereafter. One of the key tax considerations in these deals is whether the investor is technically a partner for tax purposes. Pitney Bowes experienced this issue first hand in Historic Boardwalk where the Third Circuit ruled that Bowe’s affiliate was not a partner for tax purposes and all of the tax credits and deductions should have been allocated to the developer of the project (the case was denied certiorari by the Supreme Court).

The recently released FAA 20161101F similarly concludes that the tax credit investor was not a partner for tax purposes. In this instance the deal involved IRC § 45(c)(7) coal credits. In ruling against partner status the IRS went over the factors in most of the seminal cases in this area such as, Culbertson, Castle Harbour, and Historic Boardwalk. IRS Associate Area Counsel painstakingly analyzed the various agreements and the facts and decided that the following factors indicated that the investor was not a partner but it merely bought tax credits. First, the investor’s contributions were contingent on the number of tons of refined coal that were produced by the facility.  The purported capital contributions were largely to be made in the future and only in relation to the amount of refined coal, and thus by extension only when tax credits were generated. Second, there was an indemnification agreement that protected the contributions and tax credits of the investor.  Third, the statements of the parties and promotional materials indicated that the parties were interested in the generation and allocation of tax benefits, not in undertaking a joint endeavor to operate a profitable refined coal facility. Fourth, the relationship of the parties was akin to that of a buyer and seller of refined coal tax credits. Finally, the “investment” lacked any downside risk or pre-tax upside potential. 

Judging from the facts description in the ruling, it is safe to assume  that this coal credit deal  was not structured with the 2007 and the Rev. Proc. 2014-12 safe-harbors in mind. The ruling offers yet another warning to tax equity investors to thread very carefully when structuring their partnership participation. Ultimately the tab may have to be picked up by the facility operator because of all the indemnities, but this type of structuring footfall is sure to lead to litigation and unnecessary cost and could have been avoided in the first place.
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