Tax Practice Group. July 27, 2009

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1 July 27, 2009 Treasury Issues Guidance for Cash Grants In Lieu of Renewable Energy Tax Credits Creating New Opportunities for Alternative Energy Developers and Investors On July 9, 2009, the U.S. Department of the Treasury (Treasury) issued guidelines for claiming cash grants payable pursuant to section 1603 of the American Recovery and Reinvestment Act of 2009 (Section 1603 Grants). Section 1603 Grants are cash payments made to a person who either places qualifying energy property in service during 2009 or 2010 or begins construction of qualifying energy property during 2009 or 2010 and places the property in service by its specified credit termination date. The guidelines, terms and conditions and a sample application form are available at This client alert summarizes the Treasury guidance and some opportunities now available under this program. Background For more information, contact: L. Wayne Pressgrove (404) wpressgrove@kslaw.com Dustin M. Covello (404) dcovello@kslaw.com King & Spalding Atlanta 1180 Peachtree Street, NE Atlanta, Georgia Tel: (404) Fax: (404) Renewable energy projects in the United States generally receive significant financing from tax equity investors. These investors receive a significant portion of their return on investment in renewable energy projects in the form of U.S. federal tax credits and tax depreciation deductions. The tax equity market dramatically contracted in late 2008 due to the combination of seized credit markets and the decline or elimination of the investors tax base needed to utilize the tax benefits. Section 1603 Grants were created to provide a government incentive in situations where the tax credit approach was no longer viable. Eligible Property Only qualified investments in specified energy property are eligible for the Section 1603 Grants. Specified energy property is property eligible for the investment tax credit (ITC) under section 48 of the Internal Revenue Code of 1986 (the Code). This includes facilities eligible for the production tax credit (PTC) under section 45 of the Code which may elect to claim the ITC instead of the PTC. The Page 1 of 6

2 property must be an integral part of the activity performed at the qualified facility and be depreciable or amortizable for U.S. federal income tax purposes. Section 1603 Grants must be claimed in lieu of the ITC or PTC that would otherwise be claimed with respect of a facility. To be eligible, qualifying property must also meet certain placed in service or construction deadlines. An applicant must either (i) place the property in service during 2009 or 2010 or (ii) place the property in service after 2010 and before the applicable credit termination date, but only if construction of the property begins in 2009 or Specified energy property may be an addition to, or an expansion of, a qualified facility placed in service before 2009 if the expansion is capable of operating as an independent unit. The credit termination date ranges from January 1, 2010 to January 1, 2017, depending upon the type of eligible property. The Section 1603 Grant amount is equal to the amount of allowable ITCs. This is generally 30% of the basis of qualifying property. The grant amount is 10% for geothermal property, qualified microturbine property, combined heat and power system property, or geothermal heat pump property. The credit termination date and the applicable percentage for qualifying facilities are set forth below. Specified Energy Property Credit Termination Date Applicable Percentage of Eligible Cost Basis Large Wind Jan 1, % Closed-Loop Biomass Jan 1, % Open-loop Biomass Jan 1, % Section 45 Geothermal Jan 1, % Landfill Gas Facility Jan 1, % Trash Facility Jan 1, % Qualified Hydropower Jan 1, % Marine & Hydrokinetic Jan 1, % Solar Jan 1, % Section 48 Geothermal Jan 1, % 1 Fuel Cells Jan 1, % 2 Microturbines Jan 1, % 3 Combined Heat & Power Jan 1, % Small Wind Jan 1, % Geothermal Heat Pumps Jan 1, % An applicant s eligible cost basis is its basis as determined in accordance with the general basis calculation rules under the Code. Therefore, eligible basis includes installation and other costs added to a property s 1 Geothermal property that meets the definition of qualified property in both section 45 and section 48 of the Code is allowed either the 30% credit or the 10% credit, but not both. 2 The grant may not exceed an amount equal to $1,500 for each 0.5 kilowatt of capacity. 3 The grant may not exceed an amount equal to $200 for each kilowatt of capacity. Page 2 of 6

3 basis for purposes of depreciation. Similarly, an applicant s eligible cost basis is reduced by amounts that are deducted for U.S. federal income tax purposes in the year they are incurred or paid. For instance, an applicant that deducts intangible drilling and development expenses attributable to geothermal property cannot include these amounts in its eligible basis. An applicant may claim a Section 1603 Grant for eligible property that is installed alongside ineligible property or has been retrofitted onto previously placed in service property. However, in these cases, only the portion of an applicant s costs attributable to eligible property is eligible for a Section 1603 Grant. An applicant s receipt of a Section 1603 Grant has some collateral tax tradeoffs. Section 1603 Grants are not treated as taxable income. Similar to the ITC, the applicant must reduce its basis in eligible property by 50% of the grant amount. For example, if an investment qualifies for a Section 1603 Grant of $30, the applicant s basis for depreciation in the eligible property is reduced by $15. When construction is considered to begin is determined by when an applicant (or another person pursuant to a qualifying contract) begins physical work of a significant nature. Certain traps for the unwary exist in determining the beginning of construction. For instance, an applicant s clearing and excavating of a site to build a wind turbine is deemed a preliminary activity rather than the beginning of construction. Moreover, an applicant may accidentally cease the beginning of construction if the applicant and his construction contractor make more than insubstantial changes to a binding construction contract. Under a safe harbor, the applicant will conclusively begin construction if the applicant incurs more than 5% of the total cost of the eligible property (excluding the cost of the land and preliminary activities such as planning or designing, securing financing, exploring, or researching). Eligible Investors Most individuals and business entities are eligible to receive a Section 1603 Grant. Significantly, however, ineligible investors include agencies and instrumentalities of state and local governments and entities that are exempt from tax under section 501 of the Code. This disqualifies pension funds from investing directly or indirectly in eligible property as well as many private equity funds due to the participation of tax-exempt investors in such funds. Indirect investment includes holding equity in a partnership or other pass-through entity, but does not include indirect investment held through a taxable C corporation. Thus, private equity funds and their tax-exempt investors may invest through blocker corporations without jeopardizing the availability of the Section 1603 Grant. Non-U.S. investors, including foreign investment funds, should be able to structure either a direct or indirect investment in eligible property. Foreign individuals and entities can be eligible investors if 50% or more of such investor s gross income derived from eligible property is either subject to U.S. federal income tax or included in the income of a United States shareholder under the controlled foreign corporation rules of the Code. This should generally be the case. Alternatively, a blocker corporation could be utilized to make the investment. Page 3 of 6

4 Lessees of so-called inverted pass-through lease structures (which are widely used in the solar power industry) are also eligible investors, subject to certain limitations and qualification rules. First, both the lessee and the lessor must qualify as eligible investors. Second, the lessor must waive all rights to the applicable Section 1603 Grant as well as the production and investment tax credits. Third, certain lessors, including REITs, may not pass through a Section 1603 Grant to a lessee. Fourth, and most importantly, the lessee must include half of a Section 1603 Grant as income ratably over a five year basis. This income inclusion requirement has the effect of treating a lessee who receives a Section 1603 Grant in a similar manner to a property owner who receives a Section 1603 Grant, which must reduce its basis in eligible property by half of the grant. Possible Recapture Section 1603 Grants are subject to recapture if an applicant either ceases using the property as eligible property or disposes of the property to an ineligible person within five years from the date the applicant places the property in service. Temporary cessation of production will not result in recapture. Property is considered to have been disposed of to a disqualified person if any interest in the property or in any partnership or pass-through entity that has a direct or indirect ownership interest in the applicant is sold to a disqualified investor. However, disposing of an interest to an entity other than a disqualified investor will not result in recapture provided that the property continues to qualify as specified energy property and the acquirer agrees to be jointly liable with the applicant for any recapture amounts. The amount subject to recapture decreases ratably over five years. For example, if the applicant sells the property to a disqualified investor three years after placing the property in service, the applicant must repay 40% of Section 1603 Grant. Recapture amounts are treated as a non-tax claim owed to the United States. This means that the government's claim is that of an unsecured creditor and is not eligible to become a tax lien. Applicants are not required to post security as a condition of receiving a Section 1603 Grant. Partnership Tax Issues Treasury guidance regarding Section 1603 Grants does not address the partnership tax issues relating to the receipt of the grants. The Code and Treasury regulations generally address the effects of an ITC for a partnership and its partners, but it is unclear whether these provisions apply equally to the receipt of a Section 1603 Grant. The effect of the grant on capital accounts and partners basis in their partnership interests is unclear. It is also unclear how any adjustments to capital account balances and partnership interest basis should be allocated among the partners. Although the better answer should be to follow the rules applicable to ITCs, it would be helpful if the Treasury confirmed this result. Page 4 of 6

5 Application Procedures The Treasury will receive applications between August 1, 2009 and the statutory deadline of October 1, If an applicant places the property in service during 2009 or 2010, the applicant must apply after the applicant places the property in service (but before the statutory deadline). If approved, Treasury will make payments to such applicants within 60 days of receiving the application. If an applicant begins construction during 2009 or 2010, but will not place the property in service until after the statutory deadline, the applicant must submit an application after construction begins. If approved, Treasury will make payments to such applicants within 60 days of the Treasury s final review of the completed application. An applicant may apply online at The application packet includes the application itself and mandatory terms and conditions. The application must also include certain supporting documentation. Treasury will pay an applicant by electronic funds transfer within five days of notifying the applicant of approval. An applicant must possess a Data Universal Numbering System number (which is available for no cost by calling Dunn & Bradstreet at ). This number must be included on the application. An applicant must also register as a federal government contractor through the Central Contractor Registration system at This registration must be completed before Treasury will make any Section 1603 Grants to an applicant. Applicants will be required to agree to the Treasury s terms and conditions under penalty of perjury. The terms and conditions include representations by the applicant regarding the status of the applicant, a covenant that the applicant will not claim an investment or production tax credit, and reporting and record keeping obligations. Applicants must certify to the Treasury on an annual basis for five years that the property has not been disposed of to a disqualified person. In addition, applicants must provide periodic performance reports specifying, among other things, the number of jobs retained, annual production, and installed nameplate capacity. Applicants are also required to acknowledge that the Treasury may share applicant information and to agree that the may publicly release the names of applicants and descriptions of projects. Treasury has created a streamlined process to answer questions regarding the program. Interested applicants may Treasury at 1603Questions@do.treas.gov. Miscellaneous Applicants may assign their rights to a Section 1603 Grant directly to a third party. Assignments must meet the requirements of the Federal Assignment of Claims Act. The grant should be assignable to financial institutions such as banks and trust companies provided appropriate notice is given. Page 5 of 6

6 Receipt of a Section 1603 Grant does not make the property subject to the requirements of the Davis-Bacon Act. Receipt of Section 1603 Grants also does not make the property subject to the National Environmental Policy Act. IRS Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. King & Spalding is an international law firm with more than 880 lawyers in Abu Dhabi, Atlanta, Austin, Charlotte, Dubai, Frankfurt, Houston, London, New York, Riyadh (affiliated office), San Francisco, Silicon Valley and Washington, DC. The firm represents half of the Fortune 100 and in Corporate Counsel surveys consistently has been among the top firms representing Fortune 250 companies. For additional information, visit This alert provides a general summary of recent legal developments. It is not intended to be and should not be relied upon as legal advice. Page 6 of 6