Project Development, Wind Power

Court to US Treasury: ‘Basis Equals Purchase Price’

The U.S. Court of Federal Claims decided that Halloween was the perfect day to release its Alta v. United States opinion, and the plaintiffs are enjoying the treat.

Plaintiffs sued the Treasury for the alleged underpayment of over $206 million in grants under section 1603 of the American Recovery and Reinvestment Tax Act of 2009, which provides owners of certain renewable energy projects a grant equal to 30 percent of the property’s “basis.”

“And therein lies the dispute.”

Emphasizing the general rule that basis “is the cost of property to its owner,” the court awarded plaintiffs the full grant amount.

For 19 of the 20 plaintiffs, the purported basis was set via sale-leaseback transactions. For one, via an outright sale. Each of the wind projects were contracted to Southern California Edison pursuant to a power purchase agreement (PPA). All projects were sold prior to the start of commercial operation.

The government, denying the full grant, argued that basis should be “the value of each wind farm’s grant-eligible constituent parts and their respective development and construction costs.” Any other value would be allocated to goodwill or “going-concern.”

Plaintiffs’ proposed eligible basis was purchase price “minus small allocations for ineligible property, such as land and transmission lines.”

The government’s expert witness failed to disclose texts he authored for Marxist and East German publications. In light of this omission, the court excluded his testimony.

Below is a summary of the salient points to take from the Alta opinion.

1. The PPA Was Allocated No Basis

Analogizing the PPA to a ground lease transferred in connection with the sale of the fee simple interest in land, the court held that the PPA cannot be “considered a separate asset from the underlying land, even if the land lease terms are better than market.” (1.) Further, the PPA related only to specific facilities, neither transferable nor assignable.

This finding conflicts with the IRS’s revocation of a prior taxpayer-friendly private letter ruling, (2) and it is unclear which precedent the industry will follow. While court cases have greater precedential value than PLRs, this case will likely be appealed, further confusing the issue. (3.)

2. Projects Have Neither Goodwill nor “Going Concern” Value Prior to Being Operational (4)

Goodwill was defined as the expectancy of continued patronage and the “ability to attract and maintain customer relationships over time.” Therefore, “the fact that the Alta facilities… were not yet operational when purchased is dispositive.” Finally, because “the value of an asset’s permanent location is part of the basis of the asset,” the court rejected the argument that facility location creates goodwill.

The court defined “going concern” value as the “special value inherent in a functioning established plant continuing to operate, to do business, and to earn money.” However, assets yet to reach commercial operations cannot “continue to operate.” For there to be going concern, something must be going.

3. Turnkey Value Is Part of the Tangible Assets

The court next rejected the attempt to place any of the transaction’s turnkey value under nonexistent goodwill or “going concern” value because such value was not similar to either; rather than purchasing an existing business, the buyer “is purchasing a put-together facility that is ready for operation.” The value comes from the tangible assets’ potential, not some other intangible.

4. Neither Alta’s Sale-Leaseback nor Its Tax Indemnities Created the “Peculiar Circumstances” Necessary to Disregard Plaintiff’s Basis Estimate

Generally, if the court finds “peculiar circumstances” in a deal’s structure, it can disregard that structure. (5.) Here, because the “Section 1603 grant program explicitly envisioned sale-leaseback structures,” the court required “some indication that the parties… adjusted various aspects of the sale and leaseback prices in order to highly inflate the purchase prices.” It found no such indication because prices paid for the sale-leaseback projects were comparable to the project sold outright. Additionally, the rent prepayments under the lease made business sense, providing the lessee “breathing room” if revenues were lower than expected.

The project sponsor also indemnified the plaintiffs for shortfalls in the section 1603 grant, yet this was not “peculiar.” “[T]he reality that the tax laws affect the shape of most business transactions cannot be ignored.” (6.) The court wrote “that similar tax-related indemnities are common in complex commercial transactions,” serving only to “confirm the fair market value of the facilities once expected grant amounts were taken into account.”

5. Pro Rata Indirect Cost Allocation Is a Valid Basis-Determination Method

Absent “peculiar circumstances,” the court assessed plaintiffs’ process for determining asset eligibility for section 1603 grants. The sponsor provided to the plaintiffs cost schedules for the projects that showed indirect costs effectively becoming part of the asset. Some indirect costs were eligible, some not, and some were partially eligible and partially ineligible. “Such indirect costs were apportioned pro rata among all of the direct costs.”

The government argued that plaintiffs’ methodology was inaccurate because section 1603 property increased the wind farm value such that a plaintiffs’ method would overstate eligible basis; calculating asset value by cost would be better. However, there was no evidence presented that plaintiffs’ method was unreasonable.

The court was not persuaded by the government’s “attack[s] on the logic behind any pro rata allocation method.” It said, “[i]n the real world, this grant-eligible property is hopelessly intertwined with grant-ineligible property…. [A]ny pro-rata allocation method will necessarily involve extrapolation based on the construction and development costs of the grant-eligible and grant-ineligible property under section 1603” and that plaintiffs took the “least imperfect way possible.”

Conclusion

This case was about foundational principles of the allocation calculation. Though a victory, it remains to be seen if subsequent section 1603 cases will distinguish the Alta judgment due to the government’s lack of an expert witness.

Jeffrey G. Davis (left) is a partner in the Tax Transactions & Consulting group in Mayer Brown’s Washington DC office and is a co-head of the firm’s Renewable Energy group. Jeff represents major corporations, financial institutions and private equity funds on a wide range of US federal income tax matters. His practice focuses on partnership tax, tax credits and other incentives, and project finance and development.

David K. Burton is a partner in Mayer Brown’s New York office and a member of the Tax Transactions & Consulting practice.  He leads Mayer Brown’s Renewable Energy group in New York.  He advises clients on a wide range of US tax matters, with a particular emphasis on project finance and energy transactions. In addition, he also advises clients on tax matters regarding the formation and structuring of domestic and offshore investment funds. 

A longer version of this article was originally published by Mayer Brown. This article was republished with permission.

  1. See Schubert v. Comm’r, 33 T.C. 1048, 1053 (1960), aff’d, 286 F.2d 573 (4th Cir. 1961).
  2. P.L.R. 201214007 (Jan. 3, 2012).
  3. Rule 4(a)(1)(B)(i) FRCP.
  4. The parties’ focus on goodwill and “going concern” value stemmed from the potential application of I.R.C. § 1060. If the assets were found to have either goodwill or “going concern” value, the parties would have been forced to apply the “‘residual method’ of pricing as provided in I.R.C. § 338(b)(5) to value the grant-eligible assets,” effectively eviscerating plaintiffs’ basis calculation.
  5. Lemmen v. Comm.’r, 77 T.C. 1326, 1348 (1981) (quoting Bixby v. Comm’r, 58 T.C. 757, 776 (1972)).
  6. Quoting Tanner v. Comm’r, T.C. Mem. 1992-235, 1992 WL 79077 (April 21, 1992).